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Overview
I. Conditions for Oligopoly?
II. Role of Strategic Interdependence
III. Profit Maximization in Four Oligopoly
Settings
• Sweezy (Kinked-Demand) Model
• Cournot Model
• Stackelberg Model
• Bertrand Model
IV. Contestable Markets
Oligopoly Environment
PH
P0
PL
Q
QH1 QH2 Q0 QL2 QL1
P D2 (Rival matches your price change)
P0
D1
(Rival holds its
price constant)
D
Q0 Q
Key Insight
• The effect of a price reduction on the quantity
demanded of your product depends upon whether
your rivals respond by cutting their prices too!
• The effect of a price increase on the quantity
demanded of your product depends upon whether
your rivals respond by raising their prices too!
• Strategic interdependence: You aren’t in complete
control of your own destiny!
Sweezy (Kinked-Demand) Model
Environment
• Few firms in the market serving many
consumers.
• Firms produce differentiated products.
• Barriers to entry.
• Each firm believes rivals will match (or follow)
price reductions, but won’t match (or follow)
price increases.
• Key feature of Sweezy Model
• Price-Rigidity.
Sweezy Demand and Marginal Revenue
P
D2 (Rival matches your price change)
P0
D1
(Rival holds its
price constant)
MR1
MR2
Q0 Q
MRS: Sweezy MR
Sweezy Profit-Maximizing Decision
P
D2 (Rival matches your price change)
MC1
MC2
P0 MC3
Q2
Q1 Q1M Q1
Cournot Equilibrium
Q2 *
r
2
Q1 * Q1 M (a-c2)/b
Q1
Summary of Cournot Equilibrium
• The output Q1* maximizes firm 1’s profits,
given that firm 2 produces Q2*.
• The output Q2* maximizes firm 2’s profits,
given that firm 1 produces Q1*.
• Neither firm has an incentive to change its
output, given the output of the rival.
• Beliefs are consistent:
• In equilibrium, each firm “thinks” rivals will
stick to their current output – and they do!
Firm 1’s Isoprofit Curve
Q2 The combinations of outputs of the two firms
that yield firm 1 the same level of profit
r1
B
C Increasing
Profits for
A 1 = $100 Firm 1
D
1 = $200
Q1M Q1
Another Look at Cournot Decisions
Q2
Q2*
1 = $100
1 = $200
Q1* Q1M Q1
Another Look at Cournot
Equilibrium
Q2
r1 Firm 2’s Profits
Q2*
r2
Q1* Q1M Q1
Impact of Rising Costs on the
Cournot Equilibrium
Q2
r1*
Cournot equilibrium after
firm 1’s marginal cost increase
r1**
Q2**
Cournot equilibrium prior to
firm 1’s marginal cost increase
Q2*
r2
Q1** Q1*
Q1
Collusion Incentives in Cournot
Oligopoly
Q2
r1
2Cournot
Q2M
1Cournot
r2
Q1M Q1
Stackelberg Model Environment
• Few firms serving many consumers.
• Firms produce differentiated or homogeneous
products.
• Barriers to entry.
• Firm one is the leader.
• The leader commits to an output before all other
firms.
• Remaining firms are followers.
• They choose their outputs so as to maximize
profits, given the leader’s output.
Stackelberg Equilibrium
Q2 π2C Follower’s Profits Decline
r1
πFS
Stackelberg Equilibrium
Q2C
Q2 S
π1 C
S
r2
πL
Q1 C Q1 S Q1 M Q1
The Algebra of the Stackelberg Model