Chapter-9:

Basic Oligopoly Model

by Traheka Erdyas Bimanatya, M.Sc.

Managerial Economics | 23 May 2019

Outline
―What is Oligopoly Market?
―Further Discussions on Basic Oligopoly Models.
▪ Sweezy Model
▪ Cournot Model
▪ Stackelberg Model
▪ Bertrand Model (+ Contestable Market)

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PART 1:
WHAT IS OLIGOPOLY MARKET?
What is oligopoly market ?
▪ Oligopoly market structures are characterized by only a few firms, each of
which is large relative to the total industry.
– Typical number of firms is between 2 and 10.
– Products can be identical or differentiated.

▪ Oligopoly settings tend to be the most difficult to manage since managers must
consider the likely impact of his or her decisions on the decisions of other firms
in the market.

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Firm’s and Market Demand
An oligopoly market composed of two firms is called a duopoly.

Price
Demand if rivals
C match price changes

Demand if rivals do not

A
B match price changes
𝑃0

Demand2
Demand1

0 𝑄0 Output
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Different Models of Oligopoly Market
▪ Sweezy
– Produce differentiated products.
– Each firm believes its rivals will cut
their prices in response to a price
reduction but will not raise their prices
in response to a price increase.
▪ Bertrand
– Produce identical products.
– Engage in price competition.
– Consumers have perfect information
and there are no transaction costs.
▪ Cournot
– Produce either differentiated or
homogeneous products.
– Each firm believes rivals will hold their
output constant if it changes its output.
▪ Stackelberg
– Produce either differentiated or
homogeneous products.
– Output determination follows
leader-follower pattern.
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What is isoprofit curves?
A function that defines the combinations of outputs produced by all firms that yield
a given firm the same level of profits.

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PART 2:
BASIC OLIGOPOLY MODELS
What is Sweezy Oligopoly?
Price Each firm believes its rivals
will cut their prices in response
to a price reduction but will not
Sweezy Demand MC0 raise their prices in response
A to a price increase.
B
𝑃0
MC1
C Demand1
(rival holds price
constant)

E MR1
MR Demand2
(rival matches price change)

0 𝑄0 F Output
MR2
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What is Cournot Oligopoly?

Quantity2 Each firm makes an output

decision under the belief that is
Firm 1’s Reaction Function rival will hold its output constant
𝑄1 = 𝑟1 𝑄2
when the other changes its
output level.
𝑄2 𝑀𝑜𝑛𝑜𝑝𝑜𝑙𝑦
Cournot equilibrium
𝐶𝑜𝑢𝑟𝑛𝑜𝑡
𝑄2 C
Firm 2’s Reaction Function
D A 𝑄2 = 𝑟2 𝑄1
B

𝑄1 𝐶𝑜𝑢𝑟𝑛𝑜𝑡 𝑄1 𝑀𝑜𝑛𝑜𝑝𝑜𝑙𝑦 Quantity1

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What is Collusion?

▪ Markets with only a few dominant firms

can coordinate to restrict output to
their benefit at the expense of
consumers.
– Restricted output leads to higher
market prices.

▪ Collusion, however, is prone to cheating

behavior.
– Since both parties are aware of these
incentives, reaching collusive
agreements is often very difficult.

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 What is Stackelberg Oligopoly?
Quantity Follower
▪ A single firm (the leader)
𝜋2 𝐶𝑜𝑢𝑟𝑛𝑜𝑡 chooses an output before all other
𝑟 𝐿𝑒𝑎𝑑𝑒𝑟 𝜋2 𝑆𝑡𝑎𝑐𝑘𝑒𝑙𝑏𝑒𝑟𝑔 𝐹𝑜𝑙𝑙𝑜𝑤𝑒𝑟
firms choose their outputs.
▪ All other firms (the followers)
𝑟 𝐹𝑜𝑙𝑙𝑜𝑤𝑒𝑟 take as given the output of the
𝑄2 𝑀
leader and choose outputs that
maximize profits given the leader’s
output.
𝑆𝑡𝑎𝑐𝑘𝑒𝑙𝑏𝑒𝑟𝑔 𝜋1 𝐶𝑜𝑢𝑟𝑛𝑜𝑡
𝑄2 𝐹𝑜𝑙𝑙𝑜𝑤𝑒𝑟

𝜋1 𝑆𝑡𝑎𝑐𝑘𝑒𝑙𝑏𝑒𝑟𝑔 𝐿𝑒𝑎𝑑𝑒𝑟

𝑄1 𝑀 𝑄1 𝑆𝑡𝑎𝑐𝑘𝑒𝑙𝑏𝑒𝑟𝑔 𝐿𝑒𝑎𝑑𝑒𝑟 Quantity Leader

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What is Bertrand Oligopoly?
▪ Firms in this market will undercut one another to capture the
entire market leaving the rivals with no profit.
‒ All consumers will purchase at the low-price firm.

▪ This “price war” would come to an end when the price each firm
charged equaled marginal cost.

▪ In equilibrium, 𝑷𝟏 = 𝑷𝟐 = 𝑴𝑪.
– Socially efficient level of output.
– No market power.
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What is Contestable markets ?
▪ It involve strategic interaction among existing firms and potential
entrants into a market.

▪ A market is contestable if:

– All producers have access to the same technology.
– Consumers respond quickly to price changes.
– Existing firms cannot respond quickly to entry by lowering price.
– There are no sunk costs.

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Q & A #1
ANY QUESTIONS UP TO THIS
POINT?
 THANK YOU
Traheka Erdyas Bimanatya, M.Sc. traheka.erdyas.b@ugm.ac.id

Traheka Erdyas Bimanatya