Oligopoly

• Not a game of rummy or solitaire but bridge, poker, or chess

• Actions of players are interdependent
• Strategic interaction based on conjecturing actions of others
• Structure:
• Large # of consumers
• A few sellers
• Homogeneous or differentiated products
• Higher entry barriers
• Conduct:
• Firms interact on the basis of quantity or price
• Strategic interaction among firms
• Advertisement present
• Performance
• Any outcome, from competitive to collusive is possible
• DWL varies based on degree of competition
• Collusive oligopoly
• Official cartels/collusion, tacit collusion, price leadership, mergers
• Non-collusive oligopoly
• Rigid pricing & kinked demand, limit pricing, non-cooperative game
© IIMA (Prof. Satish Deodhar) Page 1
 Cournot Duopoly
Market Demand: P = 500 – 0.5Q Q = q1 + q2 MC = AC = 200, for firm1 and firm 2 No fixed cost

P q1 = R1 = [500 – 0.5Q] q1 Assume that firms choose qi

₹
R1 = [500 – 0.5(q1 + q2)] q1 R1 = 500 q1 - 0.5q21 – 0.5q1 q2

dR1/dq1 = MR1 = d [500 q1 - 0.5q21 – 0.5q1 q2 ] /dq1

MR1 = 500 - q1 – 0.5[q1 (dq2/dq1 ) + q2] (1)

When profit is maximized, MR = MC, therefore,

500 - q1 – 0.5[q1 (dq2/dq1 ) + q2] = 200
Assume firm 1 is a follower, i.e., considers
output of firm 2 as given, i.e., (dq2/dq1 ) = 0
(dq2/dq1 ) = Conjectural Variation = CV1 = 0

500 - q1 – 0.5q2 = 200

q1 = 300 – 0.5q2
D Reaction Function of Firm 1 (rf1)

© IIMA (Prof. Satish Deodhar) Page 2

q2 Both firms are Follower (passive behavior)
rf 1: q1 = 300 – 0.5q2 Similarly, rf 2: q2 = 300 – 0.5q1 CV2 = (dq1/dq2) = 0

q1 = 300 – 0.5[300 – 0.5q1]

600 rf1
q1 = 300 – 150 + 0.25q1

q1 = 150 + 0.25q1 0.75q1 = 150 q1 = 150/0.75 q1 = 200

q2 = 200
300 Q = 400 P = 500 – 0.5 (400)
P = 300
R1 = R2 = (300) (200)
C1 = C2 = (200) (200)
ϖ1 = ϖ2 = (300) (200) – (200) (200)
ϖ1 = ϖ2 = (200) [300 – 200]
rf2
ϖ1 = ϖ2 = 20,000
300 600 q1 ϖT = 40,000

© IIMA (Prof. Satish Deodhar) 3

 … Cournot Duopoly

₹ Firm 2
Profits Follower Leader
Firm 1 Follower 20,000 ; 20,000
Leader

P = 300

200

400 Q

© IIMA (Prof. Satish Deodhar) Page 4

 Firm 1 is Leader & Firm 2 is
Follower

rf2: q2 = 300 – 0.5q1 q2 = 300 – 0.5q1

q2 = 300 – 0.5 (300)
dq2/dq1 = -0.5 = CV1
q2 = 300 – 150 = 150
(1) MR1 = 500 - q1 – 0.5[q1 (dq2/dq1 ) + q2]
MR1 = 500 - q1 – 0.5[-0.5q1 + q2] Q = 300 + 150 = 450

500 - q1 – 0.5[-0.5q1 + q2] = 200

P = 500 – 0.5 (450)
q1 – 0.25q1 + 0.5q2 = 300
P = 500 – 225 = 275
0.75q1 + 0.5q2 = 300
q1 + 0.50/0.75 q2 = 300/0.75 ϖ1 = (275)(300) – (200)(300)
q1 + (2/3) q2 = (300) 4/3 ϖ1 = (300) (75) = 22,500

(3) rf1: q1 = 400 – (2/3)q2 ϖ2 = (275)(150) – (200)(150)

q1 = 400 – (2/3)[300 – 0.5q1] ϖ2 = (150) (75) = 11,250
q1 = 400 – 200 + (1/3)q1 ϖT = 33,750
q1 = 200 + (1/3)q1
(2/3)q1 = 200
q1 = 300

© IIMA (Prof. Satish Deodhar) 5

 … Cournot Duopoly

₹ Firm 2
Profits Follower Leader
Firm 1 Follower 20,000 ; 20,000 11,250 ; 22,500
Leader 22,500 ; 11,250

P = 300

P =275

200

400 450 Q

© IIMA (Prof. Satish Deodhar) Page 6

 Both firms are Leader
(3) rf1: q1 = 400 – (2/3)q2 rf2: q2 = 400 – (2/3)q1

q1 = 400 – (2/3)[400 - (2/3)q1]

q1 = (1/3)400 + (4/9)q1
(5/9)q1 = (1/3)400
q1 = (1/3)(9/5)400
q1 = (3/5)400
q1 = 240
q2 = 240
Q = 480

P = 500 – 0.5 (480)

P = 500 – 240 = 260

ϖ1 = ϖ2 = (260)(240) – (200)(240)

ϖ1 = ϖ2 = (240)(60) = 14,400
ϖT = 28,800

© IIMA (Prof. Satish Deodhar) 7

 … Cournot Duopoly

₹ Firm 2
Profits Follower Leader
Firm 1 Follower 20,000 ; 20,000 11,250 ; 22,500
Leader 22,500 ; 11,250 14,400 ; 14,400

P = 300

P = 275
P = 260

200

400 450 480 Q

© IIMA (Prof. Satish Deodhar) Page 8

 Perfect Competition

P = MC = 200 CV1 = dq2/dq1 = -1 = CV2 = dq1/dq2

P = 500 – 0.5 Q This implies P remains same: price given from

outside in perfectly competitive market
200 = 500 – 0.5 Q
0.5Q = 300 MR1 = 500 - q1 – 0.5[q1 (dq2/dq1 ) + q2] (1)
Q = 600 MR1 = 500 - q1 – 0.5[q1 (-1) + q2]
MR1 = 500 - q1 + 0.5q1 – 0.5q2
ϖT = (200)(600) – (200)(600)
MR1 = 500 - q1 + 0.5q1 – 0.5q2 = 200
ϖT = 0 0.5q1 + 0.5q2 = 300
q1 = 300/0.5 – q2
q1 = 600 – q2 : rf1
q2 = 600 – q1 : rf2
q1 + q2 = 600

ϖ1 = ϖ2 = (200)(qi) – (200)(qi) = 0

© IIMA (Prof. Satish Deodhar) 9

 … Cournot Duopoly

₹ Firm 2
Profits Follower Leader
Firm 1 Follower 20,000 ; 20,000 11,250 ; 22,500
Leader 22,500 ; 11,250 14,400 ; 14,400

Perfect Competition
0 ; 0
P = 300

P = 275
P = 260

P =200

400 450 480 600 Q

© IIMA (Prof. Satish Deodhar) Page 10

 Collusion or Monoply
(joint profit maximization)

P = 500 – 0.5 Q CV1 = dq2/dq1 = 1 = CV2 = dq1/dq2

R = PQ = (500 – 0.5 Q) Q This implies a threat mechanism. If firm 1 dares to

produce more, the other is perceived to be threatening to
MR = 500 – Q produce equally more quantity and price will drop.
500 – Q = 200 Hence it is better not to produce more!

Q = 300 MR1 = 500 - q1 – 0.5[q1 (dq2/dq1 ) + q2] (1)

P = 500 – 0.5 Q MR1 = 500 - q1 – 0.5[q1 (1) + q2]
P = 500 – (0.5) (300) MR1 = 500 - q1 - 0.5q1 – 0.5q2
500 - q1 - 0.5q1 – 0.5q2 = 200
P = 350
1.5q1 + 0.5q2 = 300
ϖT = (350)(300) – (200)(300)
q1 + (1/3)q2 = 200
ϖT = (300)(150) q1 = 200 - (1/3)q2 : rf1
q2 = 200 - (1/3)q1 : rf2
ϖT = 45,000
q1 = 200 - (1/3)[200 - 1/3q1]
q1 = (2/3)200 + 1/9q1
(8/9)q1 = 200 (2/3)
q1 = 150 q2 = 150 Q = 300

© IIMA (Prof. Satish Deodhar) 11

 … Cournot Duopoly

₹ Firm 2
Profits Follower Leader
Firm 1 Follower 20,000 ; 20,000 11,250 ; 22,500
Leader 22,500 ; 11,250 14,400 ; 14,400

Collusion/Monopoly Perfect Competition

45,000 0 ; 0
P = 350
P = 300

P = 275
P = 260

P = 200

300 400 450 480 600 Q

© IIMA (Prof. Satish Deodhar) Page 12