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Chapter 12Monopolistic
Competition andOligopoly
Monopolistic
Competition andOligopoly
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Chapter 12 Slide 2
Monopolistic Competition
Characteristics
1) Many firms
2) Free entry and exit
3) Differentiated product
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Chapter 12 Slide 3
Monopolistic Competition
The amount of monopoly powerdepends on the degree ofdifferentiation.
Examples of this very common marketstructure include:
Toothpaste Soap
Cold remedies
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A Monopolistically CompetitiveFirm in the Short and Long Run
Quantity
$/Q
Quantity
$/QMC
AC
MC
AC
DSR
MRSR
DLR
MRLR
QSR
PSR
QLR
PLR
Short Run Long Run
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DeadweightlossMC AC
Comparison of Monopolistically CompetitiveEquilibrium and Perfectly Competitive Equilibrium
$/Q
Quantity
$/Q
D = MR
QC
PC
MC AC
DLR
MRLR
QMC
P
Quantity
Perfect Competition Monopolistic Competition
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Chapter 12 Slide 6
Oligopoly
Characteristics
Small number of firms
Product differentiation may or may not
exist
Barriers to entry
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Chapter 12 Slide 7
Oligopoly
The barriers to entry are:
Natural
Scale economies
Patents
Technology
Name recognition
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Chapter 12 Slide 8
Oligopoly
The barriers to entry are:
Strategic action
Flooding the market
Controlling an essential input
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Chapter 12 Slide 9
Oligopoly
Management Challenges
Strategic actions
Rival behavior
Question
What are the possible rival responses to a10% price cut by Ford?
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Chapter 12 Slide 10
Oligopoly
Equilibrium in an Oligopolistic Market
In perfect competition, monopoly, and
monopolistic competition the producers didnot 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.
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Chapter 12 Slide 11
Oligopoly
Equilibrium in an Oligopolistic Market
Defining Equilibrium
Firms do the best they can and have noincentive to change their output or price
All firms assume competitors are taking
rival decisions into account.
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Chapter 12 Slide 12
Oligopoly
Nash Equilibrium
Each firm is doing the best it can given
what its competitors are doing.
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Chapter 12 Slide 13
Oligopoly
The Cournot Model
Duopoly
Two firms competing with each otherHomogenous good
The output of the other firm is assumedto be fixed
Firms decide simultaneously how muchto produce
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Chapter 12 Slide 14
MC1
50
MR1(75)
D1(75)
12.5
If Firm 1 thinks Firm 2 will produce75 units, its demand curve is
shifted to the left by this amount.
Firm 1s Output Decision
Q1
P1D1(0)
MR1(0)
If Firm 1 thinks Firm 2 willproduce nothing, its demand
curve, D1(0), is the marketdemand curve.
D1(50)MR1(50)
25
If Firm 1 thinks Firm 2 will produce50 units, its demand curve is
shifted to the left by this amount.
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Chapter 12 Slide 15
Firm 2s ReactionCurve Q2*(Q1)
Firm 2s reaction curve shows how much itwill produce as a function of how much
it thinks Firm 1 will produce.
Reaction Curvesand Cournot Equilibrium
Q2
Q1
25 50 75 100
25
50
75
100
Firm 1s ReactionCurve Q*1(Q2)
x
x
x
x
Firm 1s reaction curve shows how much itwill produce as a function of how much
it thinks Firm 2 will produce. The xscorrespond to the previous example.
In Cournot equilibrium, eachfirm correctly assumes how
much its competitors will
produce and therebymaximizes its own profits.
CournotEquilibrium
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Chapter 12 Slide 16
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?
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Chapter 12 Slide 17
Oligopoly
An Example of the Cournot Equilibrium
Duopoly
Market demand is P = 30 - Q where
Q = Q1 + Q2
MC1 = MC2 = 0
The Linear Demand Curve
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Chapter 12 Slide 18
Oligopoly
An Example of the Cournot Equilibrium
Firm 1s Reaction Curve
111 )30(Revenue,Total QQPQR !!
12
2
11
1211
30
)(30
QQQQ
QQQQ
!
!
The Linear Demand Curve
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Chapter 12 Slide 19
Oligopoly
An Example of the Cournot Equilibrium
12
21
11
21111
2115
2115
0230
QQ
QQ
MCMRQQQRMR
!
!
!!
!((!
CurveReactions2'Firm
CurveReactions1'Firm
The Linear Demand Curve
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Chapter 12 Slide 20
Oligopoly
An Example of the Cournot Equilibrium
103020
10)2115(2115
21
2111
1
!!
!!
!!!!
!
QPQQQ
QQQQ
QQ 2:mEquilibriuCournot
The Linear Demand Curve
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Chapter 12 Slide 21
Duopoly Example
Q1
Q2
Firm 2sReaction Curve
30
15
Firm 1sReaction Curve
15
30
10
10
Cournot Equilibrium
The demand curve is P = 30 - Qandboth firms have 0 marginal cost.
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Chapter 12 Slide 22
Oligopoly
MCMRMR
QQRMR
QQQQPQR
!!!
!((!
!!!
and15Qwhen0
230
30)30( 2
Profit Maximization with Collusion
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Chapter 12 Slide 23
Oligopoly
Contract Curve
Q1 + Q2 = 15Shows all pairs of output Q1 and Q2 that
maximizes total profits
Q1 = Q2 = 7.5Less output and higher profits than the
Cournot equilibrium
Profit Maximization with Collusion
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Chapter 12 Slide 24
Firm 1sReaction Curve
Firm 2sReaction Curve
Duopoly Example
Q1
Q2
30
30
10
10
Cournot Equilibrium15
15
Competitive Equilibrium (P = MC; Profit = 0)
CollusionCurve
7.5
7.5
Collusive Equilibrium
For the firm, collusion is the bestoutcome followed by the Cournot
Equilibrium and then the
competitive equilibrium
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Chapter 12 Slide 25
First MoverAdvantage--The Stackelberg Model
Assumptions
One firm can set output first
MC = 0
Market demand is P = 30 - Q where Q =
total output
Firm 1 sets output first and Firm 2 thenmakes an output decision
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Chapter 12 Slide 26
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
First MoverAdvantage--The Stackelberg Model
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Chapter 12 Slide 27
Firm 1
Choose Q1 so that:
12
2
1111 30
0
Q- Q- QQPQR
MC,MCMR
!!
!!! 0t r f r
First MoverAdvantage--The Stackelberg Model
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Chapter 12 Slide 28
Substituting Firm 2s Reaction Curve
forQ2:
5.7and15:015
21
1111
!!!
!((!
QQMRQQRMR
2
11
11
2
111
2115
)2115(30
QQ
QQQQR
!
!
First MoverAdvantage--The Stackelberg Model
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Chapter 12 Slide 29
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 moreappropriate?
First MoverAdvantage--The Stackelberg Model