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Slide1
Chapter 12
Imperfect Competition
Slide2
The profit-maximizing output for the monopoly
2
If there are no other market entrants, the entrepreneur can earn monopoly profits that are equal to the area dcba.
Quantity
0
Price,
Cost
AC
MC
D
MR
c
a
b
d
Slide3
Chapter Preview
Most markets fall in between perfect competition and monopoly.
An
oligopoly is a market with only a few firms, and their behavior is interdependent.There is no one oligopoly model. In general we want to consider:Short run: pricing and output decision of the firms.Long run: advertising, product development.Very long run: entry and exit.
Slide4
Pricing of Homogeneous Products: An Overview
Price
Quantity per week
D
MR
MC = AC
Q
PCP
MPPC
Q
M
Perfect competition and the Bertrand model (firms choose prices).
Monopoly and the perfect cartel outcome.
Cournot outcome (firms choose output).
Slide5
Pricing of Homogeneous Products: An Overview
So in an oligopoly there can be a variety of outcomes:
If the firms act as a cartel, get the monopoly solution.
If the firms choose prices simultaneously, get the competitive solution.If the firms choose output simultaneously get some outcome between perfect competition and monopoly.
Slide6
Cournot Theory of Duopoly & Oligopoly
Cournot model
Two firms
Choose quantity simultaneouslyPrice - determined on the marketCournot equilibriumNash equilibrium
6
Slide7
The demand curve facing firm 1
7
Quantity
0
Price, Cost
MC
MR
M
D
M
(q
1
)
A
D
1
(q
1
,q
2
)
A-bq
2
q
1
2
q
1
1
D
2
(q
1
,q
2
’)
A-bq
2
’
MR
1
MR
2
q
1
d
eclines as firm 2 enters the market and expands its output
MR now depends on the output of the competing firm Setting MR1=MC1 gives a reaction function for firm 1Gives firm 1’s output as a function of firm 2’s output
Slide10
Reaction functions (best-response)
10
Given firm 2’s choice of q
2
, firm 1’s optimal response is q
1=f1
(q2).
Output of firm 1 (q
1)
0
Output of firm 2 (q
2
)
q
1
=f
1(q2)
Slide11
Reaction FunctionsPoints on reaction function
Optimal/profit-maximizing choice/output
Of one firm
To a possible output level – other firmReaction functions q1= f1(q2) q2 = f2(q1)
11
Slide12
Reaction functions (best-response)
12
Given firm 1’s choice of q
1
, firm 2’s optimal response is q
2=f2
(q1).
Output of firm 1 (q
1)
0
Output of firm 2 (q
2
)
q
2
=f
2(q1)
Slide13
Alternative Derivation -Reaction Functions
Isoprofit curves
Combination of
q1 and q2 that yield same profit Reaction function (firm 1)Different output levels – firm 2Tangency points – firm 1
13
Slide14
Reaction Function
14
Output of firm 1 (q
1
)
0
Output of firm 2 (q
2
)
x
y
q’
2
q
2
q
1
q’
1
Firm 1’s Reaction Function
q
1
m
Slide15
Deriving a Cournot Equilibrium
Cournot
equilibrium
Intersection of the two Reaction functionsSame graph
