P&rchapter 12 (1) Final

Chapter 12
Monopolistic
Competition and
Oligopoly
Monopolistic Competition
Characteristics
1) Many firms
2) Free entry and exit
3) Differentiated product
Chapter 12
Slide 2
The amount of monopoly power

depends on the degree of differentiation.
Examples of this very common market

structure include:
Toothpaste
Soap
Cold
Chapter 12
remedies
Slide 3
A Monopolistically Competitive
Firm in the Short and Long Run
$/Q
Short Run
$/Q
MC
Long Run
MC
AC
AC
PSR
PLR
DSR
DLR
MRSR
QSR
Quantity
MRLR
QLR
Quantity
Comparison of Monopolistically Competitive

Equilibrium and Perfectly Competitive Equilibrium
Perfect Competition
$/Q
$/Q
MC
Deadweight
loss
AC
MC
AC
P
PC
D = MR
DLR
MRLR
QC
Quantity
QMC
Quantity
Oligopoly
Characteristics
Small
number of firms
Product
differentiation may or may not exist
Barriers
to entry
Chapter 12
Slide 6
Oligopoly
The barriers to entry are:

Natural
Chapter 12
Scale economies
Patents
Technology
Name recognition
Slide 7
Oligopoly
The barriers to entry are:

Strategic
Chapter 12
action
Flooding the market
Controlling an essential input
Slide 8
Oligopoly
Management Challenges
Strategic
Rival
actions
behavior
Question
What
are the possible rival responses to a

10% price cut by Ford?
Chapter 12
Slide 9
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.
Chapter 12
Slide 10
Oligopoly
Equilibrium in an Oligopolistic Market

Defining
Chapter 12
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.
Slide 11
Oligopoly
Nash Equilibrium
Each
firm is doing the best it can given

what its competitors are doing.
Chapter 12
Slide 12
Oligopoly
The Cournot Model

Duopoly
Chapter 12
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
Slide 13
Firm 1s Output Decision

If Firm 1 thinks Firm 2 will
produce nothing, its demand
curve, D1(0), is the market
demand curve.
P1
D1(0)
If Firm 1 thinks Firm 2 will produce

50 units, its demand curve is
shifted to the left by this amount.
MR1(0)
D1(75)
If Firm 1 thinks Firm 2 will produce

75 units, its demand curve is
shifted to the left by this amount.
MR1(75)
MC1
MR1(50)
12.5 25
Chapter 12
D1(50)
50
Q1
Slide 14
Reaction Curves
and Cournot Equilibrium
Q1
100
Firm 1s reaction curve shows how much it

will produce as a function of how much
it thinks Firm 2 will produce. The xs
correspond to the previous example.
Firm 2s reaction curve shows how much it
will produce as a function of how much
it thinks Firm 1 will produce.
75
Firm 2s Reaction
Curve Q2*(Q1)
50 x
25
Cournot
Equilibrium
Firm 1s Reaction
Curve Q*1(Q2)
25
Chapter 12
In Cournot equilibrium, each

firm correctly assumes how
much its competitors will
produce and thereby
maximizes its own profits.
50
x
75
100
Q2
Slide 15
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?
Chapter 12
Slide 16
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve
An Example of the Cournot Equilibrium

Duopoly
Chapter 12
Market demand is P = 30 - Q where

Q = Q1 + Q2
MC1 = MC2 = 0
Slide 17
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve

Firm
1s Reaction Curve
Total Revenue, R1 PQ1 (30 Q)Q1

30Q1 (Q1 Q2 )Q1
30Q1 Q12 Q2Q1
Chapter 12
Slide 18
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve

MR1 R1 Q1 30 2Q1 Q2
MR1 0 MC1
Firm 1' s Reaction Curve
Q1 15 1 2 Q2
Firm 2' s Reaction Curve
Q2 15 1 2 Q1
Chapter 12
Slide 19
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve
Cournot Equilibrium : Q1 Q2
Q1 15 1 2(15 1 2Q1 ) Q1 10 Q2
Q Q1 Q2 20
P 30 Q 10
Chapter 12
Slide 20
Duopoly Example
Q1
30
Firm 2s
Reaction Curve
The demand curve is P = 30 - Q and

both firms have 0 marginal cost.
Cournot Equilibrium
15
10
Firm 1s
Reaction Curve
10
Chapter 12
15
30
Q2
Slide 21
Oligopoly
Profit
Profit Maximization
Maximization with
with Collusion
Collusion
R PQ (30 Q)Q 30Q Q

MR R Q 30 2Q
MR 0 when Q 15 and MR MC
2
Chapter 12
Slide 22
Oligopoly
Profit
Profit Maximization
Maximization with
with Collusion
Collusion
Contract Curve
Q1
+ Q2 = 15
Shows all pairs of output Q1 and Q2 that
maximizes total profits
Q1 =
Chapter 12
Q2 = 7.5
Less output and higher profits than the

Cournot equilibrium
Slide 23
Duopoly Example
Q1
30
Firm 2s
Reaction Curve
For the firm, collusion is the best

outcome followed by the Cournot
Equilibrium and then the
competitive equilibrium
Competitive Equilibrium (P = MC; Profit = 0)
15
Cournot Equilibrium
Collusive Equilibrium
10
7.5
Collusion
Curve
Chapter 12
Firm 1s
Reaction Curve
7.5 10
15
30
Q2
Slide 24
First Mover Advantage-The Stackelberg Model
Assumptions
One
MC
firm can set output first
=0
Market
demand is P = 30 - Q where Q =
total output
Firm
1 sets output first and Firm 2 then

makes an output decision
Chapter 12
Slide 25
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
Chapter 12
Slide 26
Firm 1
Choose
Q1 so that:
MR MC, MC 0 therefore MR 0
R1 PQ1 30Q1 - Q12 - Q2Q1
Chapter 12
Slide 27
Substituting Firm 2s Reaction Curve

for Q2:
R1 30Q1 Q12 Q1 (15 1 2Q1 )
15Q1 1 2 Q12
MR1 R1 Q1 15 Q1
MR 0 : Q1 15 and Q2 7.5
Chapter 12
Slide 28
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?
Chapter 12
Slide 29

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Chapter 12

The amount of monopoly power

Examples of this very common market

Comparison of Monopolistically Competitive

differentiation may or may not exist

The barriers to entry are:

The barriers to entry are:

Flooding the market

Controlling an essential input

are the possible rival responses to a

Equilibrium in an Oligopolistic Market

perfect competition, monopoly, and

oligopoly the producers must consider

Equilibrium in an Oligopolistic Market

Firms do the best they can and have no

All firms assume competitors are taking

firm is doing the best it can given

The Cournot Model

Two firms competing with each other

The output of the other firm is assumed

Firms decide simultaneously how much

Firm 1s Output Decision

If Firm 1 thinks Firm 2 will produce

If Firm 1 thinks Firm 2 will produce

Firm 1s reaction curve shows how much it

In Cournot equilibrium, each

An Example of the Cournot Equilibrium

Market demand is P = 30 - Q where

An Example of the Cournot Equilibrium

Total Revenue, R1 PQ1 (30 Q)Q1

30Q1 Q12 Q2Q1

An Example of the Cournot Equilibrium

An Example of the Cournot Equilibrium

The demand curve is P = 30 - Q and

R PQ (30 Q)Q 30Q Q

Less output and higher profits than the

For the firm, collusion is the best

Competitive Equilibrium (P = MC; Profit = 0)

First Mover Advantage-The Stackelberg Model

firm can set output first

1 sets output first and Firm 2 then

First Mover Advantage-The Stackelberg Model

consider the reaction of Firm 2

Firm 1s output as fixed and

First Mover Advantage-The Stackelberg Model

First Mover Advantage-The Stackelberg Model

Substituting Firm 2s Reaction Curve

First Mover Advantage-The Stackelberg Model

1s output is twice as large as firm 2s

1s profit is twice as large as firm 2s

is it more profitable to be the first mover?

model (Cournot or Stackelberg) is more

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