Monopolistic Competition and Oligopoly

1
Chapter 12

• Monopolistic Competition and Oligopoly

2
Monopolistic Competition

• Characteristics
• 1) Many firms
• 2) Free entry and exit
• 3) Differentiated product

3
Monopolistic Competition

• The amount of monopoly power depends on the
  degree of differentiation.
• Examples of this very common market structure
  include
• Toothpaste
• Soap
• Cold remedies

4
A Monopolistically CompetitiveFirm in the Short
and Long Run
/Q
/Q
Short Run
Long Run
Quantity
Quantity
5
Comparison of Monopolistically CompetitiveEquilib
rium and Perfectly Competitive Equilibrium
Monopolistic Competition
Perfect Competition
/Q
/Q
Quantity
Quantity
6
Oligopoly

• Characteristics
• Small number of firms
• Product differentiation may or may not exist
• Barriers to entry

7
Oligopoly

• The barriers to entry are
• Natural
• Scale economies
• Patents
• Technology
• Name recognition

8
Oligopoly

• The barriers to entry are
• Strategic action
• Flooding the market
• Controlling an essential input

9
Oligopoly

• Management Challenges
• Strategic actions
• Rival behavior
• Question
• What are the possible rival responses to a 10
  price cut by Ford?

10
Oligopoly

• Equilibrium in an Oligopolistic Market
• In perfect competition, monopoly, and
  monopolistic competition the producers did not
  have to consider a rivals response when choosing
  output and price.
• In oligopoly the producers must consider the
  response of competitors when choosing output and
  price.

11
Oligopoly

• Equilibrium in an Oligopolistic Market
• Defining Equilibrium
• Firms do the best they can and have no incentive
  to change their output or price
• All firms assume competitors are taking rival
  decisions into account.

12
Oligopoly

• Nash Equilibrium
• Each firm is doing the best it can given what its
  competitors are doing.

13
Oligopoly

• The Cournot Model
• Duopoly
• Two firms competing with each other
• Homogenous good
• The output of the other firm is assumed to be
  fixed
• Firms decide simultaneously how much to produce

14
Firm 1s Output Decision
P1
Q1
15
Reaction Curves and Cournot Equilibrium
Q1
100
75
50
25
Q2
25
50
75
100
16
Oligopoly

• Questions
• 1) If the firms are not producing at the
  Cournot equilibrium, will they adjust until the
  Cournot equilibrium is reached?
• 2) When is it rational to assume that a
  competitors output is fixed?

17
Oligopoly
The Linear Demand Curve

• An Example of the Cournot Equilibrium
• Duopoly
• Market demand is P 30 - Q where Q Q1
  Q2
• MC1 MC2 0

18
Oligopoly
The Linear Demand Curve

• An Example of the Cournot Equilibrium
• Firm 1s Reaction Curve

19
Oligopoly
The Linear Demand Curve

• An Example of the Cournot Equilibrium

20
Oligopoly
The Linear Demand Curve

• An Example of the Cournot Equilibrium

21
Duopoly Example
Q1
The demand curve is P 30 - Q and both firms
have 0 marginal cost.
Q2
22
Oligopoly
Profit Maximization with Collusion
23
Oligopoly
Profit Maximization with Collusion

• Contract Curve
• Q1 Q2 15
• Shows all pairs of output Q1 and Q2 that
  maximizes total profits
• Q1 Q2 7.5
• Less output and higher profits than the Cournot
  equilibrium

24
Duopoly Example
Q1
30
Q2
30
25
First Mover Advantage--The Stackelberg Model

• Assumptions
• One firm can set output first
• MC 0
• Market demand is P 30 - Q where Q total
  output
• Firm 1 sets output first and Firm 2 then makes an
  output decision

26
First Mover Advantage--The Stackelberg Model

• Firm 1
• Must consider the reaction of Firm 2
• Firm 2
• Takes Firm 1s output as fixed and therefore
  determines output with the Cournot reaction
  curve Q2 15 - 1/2Q1

27
First Mover Advantage--The Stackelberg Model

• Firm 1
• Choose Q1 so that

28
First Mover Advantage--The Stackelberg Model

• Substituting Firm 2s Reaction Curve for Q2

29
First Mover Advantage--The Stackelberg Model

• Conclusion
• Firm 1s output is twice as large as firm 2s
• Firm 1s profit is twice as large as firm 2s
• Questions
• Why is it more profitable to be the first mover?
• Which model (Cournot or Stackelberg) is more
  appropriate?