OLIGOPOLY

Today we will learn

` Oligopoly
` Cournot Nash equilibrium
Cournot-Nash
` Collusion
` Stackelberg games
` Bertrand equilibrium
Oligopoly

` A monopoly is an industry consisting a single firm.

` A duopoly is an industry consisting of two firms.
` An oligopoly is an industry consisting of a few firms.
P
Particularly,
l l each
h ffirm’s
’ own price or output decisions
d
affect its competitors’ profits.

` We will examine in further duopoly case.

Quantity competition
` Assume that firms compete by choosing their output
level. 
level.
` If firm 1 produces y1 units and firm 2 produces y2 units
then total quantity supplied is y1 + y2. The market price
will be p(y1+ y2).
` The firms’ total cost functions are c1(y1) and c2(y2).
Duopoly: An example
` Suppose firm 1 takes firm 2’s output level choice y2 as 
given. Then firm 1 sees its profit function as
given.  Then firm 1 sees its profit function as
Π 1 ( y1; y2 ) = p( y1 + y2 )y1 − c1 ( y1 ).
The p
problem is now,, ggiven y2, what output
p level y1
maximizes firm 1’s profit?
` Suppose inverse demand curve of the market is:
p( yT ) = 60 − yT
` Firms, I and 2, total cost curves are as following
2
c1 ( y1 ) = y1 2
c 2 ( y2 ) = 15y2 + y 2 .
Duopoly: An example
Given y2, firm 1’s profit:
y2 2
Π( y1; y2 ) = ( 60 − y1 − y2 ) y1 − y1 .
60
Firm 1’s best response to y2 :
1
y1 = R1 ( y2 ) = 15 − y2 .
4

15 y1
Duopoly: An example
Like as previous, given y1, firm 2’s profit:
y2 Π( y2 ; y1 ) = ( 60 − y1 − y2 )y2 − 15y2 − y22 .
Firm 2’s best response to y1:
45 − y1
y2 = R 2 ( y1 ) = .
4

45/4

45 y1
Duopoly: An example
y2 ` An equilibrium is when each firm’s
output level is a best response to
60 the other firm’s output level, for
then neither wants to deviate from
its output level.
`
y = R1 ( y )
*
1
*
2 y = R2 ( y )
*
2
*
1
Cournot equilibrium
8 ( )
y*1 , y*2 = (13,8) . (y1*,y2*) is Cournot-Nash
equilibrium.
ilib i
13 48
y1
Quantity competition
Firm 1’s response function y1 = R1 ( y2 ).
y2
Firm 2
2’s
s response function y2 = R 2 ( y1 ).
)

Cournot equilibrium
y1* = R1(y2*) y2* = R2(y1*)
y*2

y*
1 y1
 Collusion
` There are profit incentives for both firms to “cooperate”
by lowering their output levels.
levels
` This is collusion.
` Firms that collude are said to have formed a cartel.
cartel
` Suppose the two firms want to maximize their total profit
and divide it between them.
them Their goal is to choose
cooperatively output levels y1 and y2 that maximize
m
Π ( y1 , y2 ) = p( y1 + y2 )( y1 + y2 ) − c1 ( y1 ) − c 2 ( y2 ).
Collusion – unstable
` A profit-seeking cartel in which firms
c
cooperatively
erati el set their output
t t levels
le els is
fundamentally unstable since if one of the firms
seeks to increase profit by decreasing price.
price
Stackelberg game
` We studied cases that assumed firms choose their output
levels simultaneously.
` What if firm 1 chooses its output level first and then, firm
2 responds to this choice?
` Lets assume firm 1 is a leader and firm 2 is a follower.
` The competition is a sequential game in which the output
levels are the strategic variables.
` Such games are Stackelberg games.
Stackelberg game
` The response that follower firm 2 can make to the choice
y1 already made by the leader, firm 1 , as y2 = R2(y1).
` Firm 1 knows this reaction and so perfectly anticipates
firm 2’s reaction to any y1 chosen by firm 1.
` Leader’s profit function:
s
Π 1 ( y1 ) = p( y1 + R 2 ( y1 )) y1 − c1 ( y1 ).
)
Stackelberg game: An example
` Market inverse demand: p = 60 - yT.
` Fi ’ totall cost ffunctions
Firm’s i are respectively
i l c1(y( 1 ) = y1 2
ба c2(y2) = 15y2 + y22.
` Firm 2 is a follower.
follower Its reaction function is:
45 − y1
y 2 = R2 ( y1 ) =
4
` Leader s
Leader’s Π1 ( y1 ) = (60 − y1 − R2 ( y1 ))y1 − y12
s

profit function: 45 − y1
= (60 − y1 − )y1 − y12
4
`
y = 13.9 y = R2 ( y ) = 7.8
In equilibrium: s
1
s
2
s
1
Price competition
` Games in which firms use only price strategies and
play simultaneously are Bertrand games.
games
` Each firm’s marginal production cost is constant at c.
` All firms set their prices equal to the marginal cost c.
c
` Suppose one firm sets its price higher than another firm’s
price.
` Then the higher-priced firm would have no customers.
` Hence, at an equilibrium, all firms must set the same price.
Next time, we will study
` Asymmetric Information
0 adverse selection
0 signaling
0 moral hazard
0 incentives contracting