Imperfect competition

Content

Monopolistic competition
Oligopoly

I. Monopolistic competition
1. Definition
-

A type of market where there are a lot of

suppliers but their products are relatively
different

2. Characteristics
- Many firms
- Low entry barrier
- Differentiated product

- No collusion due to a large number of suppliers

- Advantage: diversified supply satisfy
customer not necessary to interfere much

I. Monopolistic competition
3. Demand and marginal
revenue curves
-

Demand curve: Downward sloping

(each firm is a mini-monopolist) but
more elastic than monopolists
demand curve
Marginal revenue curve:
downward sloping, twice as steep as
demand curve

I. Monopolistic competition
P

4. Maximizing
profit

max: MR=MC
P*

MAX:

MR=MC

MC
ATC
MAX

MR

Q*

I. Monopolistic competition

5. Long-run
equilibrium

MC
LAC

P=LAC
No economic profit

P*

MR
Q*

D
Q

Monopolistically Competitive
Firm in Short and Long Run
$/Q

Short Run
MR=MC

$/Q

MC

Long Run
P=LAC

MC

AC

LAC

PSR
PLR
DSR
DLR
MRSR
QSR

Quantity

MRLR
QLR

Quantity

Monopolistically Competitive
Firm in Short and Long Run

Short run
 Downward sloping demand differentiated
product
 Demand relatively elastic good substitutes
 Profits maximized when MR = MC and P > MR
 Firm making economic profits
Long run
 Profits attract new firms (no barriers to entry)
 Old firms demand decreases
 Industry output rises
 No economic profit (P = AC)
 P > MC  some monopoly power

Monopolistically and Perfectly

Competitive Equilibrium (LR)
$/Q

Monopolistic Competition

Perfect Competition

$/Q
Deadweight
loss

LMC LAC

LMC LAC

P
PC

D = MR
DLR
MRLR

QC

Quantity

QMC

Quantity

II. Oligopoly

1. Definition:
- A type of market where there are

some suppliers but holding total or at

least a very large part of market share

2. Characteristics:
-

Firms strictly depends on each other

join in a game and competitors act as
players
Firms are relatively powerful in market
Entry barrier is relatively high
Firms may choose either non-collusion
or public collusion (cartelized)

II. Oligopoly
3. Non-public collusion
- Cournot equilibrium
- Stackelberg model
- Bentrand model
- Price competition and product
differentiation
- Game theory
- Kinked demand curve

II. Oligopoly
3.1. Cournot equilibrium
-

Introduced in 1838 by Augustin Cournot

Duopoly
Assume that 2 firms produce identical product
and know market demand in advance
2 firms have decision simultaneously and must
consider the reaction from the competitor

II. Oligopoly

3.1. Cournot equilibrium

-

Inside the model:

Each firm has its own quantity decision depend
on assumption that competitors quantity is fixed

II. Oligopoly

3.1. Cournot equilibrium

-

Both firms maximize profit at: MR = MC

Optimal quantity of firm 1 depends totally on
its forecast about firm 2s quantity
Q1 = f (Q2)
Firm 1s reaction function

II. Oligopoly

3.1.Cournot equilibrium
-

Similarly, firm 2s reaction fuction:

-

Q2 = g (Q1)

Equilibrium is the intersection between 2

reaction function. At that point, firm can
forecast exactly about competitors quantity
and then maximize its profit

3.1. Cournot equilibrium

Q1

Q2=g(Q1)
Cournot equilibrium

Q1=f(Q2)

Q2

3.1. Cournot equilibrium

Example:
 Good As demand curve : P = 30 Q with
2 suppliers. Both supplier have the same
marginal cost and equal to 0. Calculate
Cournot equilibrium?

TR1=PQ1 = (30-Q)Q1= 30Q1-Q12-Q1Q2

MR1(Q1)=30-2Q1-Q2=MC1=0
Firm 1s reaction function: Q1=15-Q 2
Firm 2s reaction function : Q2=15- Q 1

Cournot equilibrium: Q1=Q2 = 10

Q1+Q2=20

P=30-Q=10
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3.1. Cournot equilibrium Example

Q1

Demand curve P = 30 - Q and MC1=MC2=0.

30
Firm 2s reaction function

Cournot equilibrium

15
10

Firm 1s reaction function

10

15

30

Q2
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3.1. Cournot equilibrium Example

Maximum profit when collusion exist

TR = PQ = (30 Q)Q = 30Q Q 2

MR = TR Q = 30 2Q
MR = 0 when Q = 15 & MR = MC

Contract curve

Q1 + Q2 = 15

Reveals combination between Q1 and Q2 to

maximize profit

Q1 = Q2 = 7.5

Less Q and higher profit than Cournot equilibrium

19

3.1. Cournot equilibrium Example

Q1
30
Firm 2s reaction
function

1. Collusion
2. Cournot
3. Competitive equilibrium

Competitive equilibrium(P = MC; Profit = 0)

15

Cournot equilibrium
Equilibrium when collusion

10
7.5

Firm 1s reaction function

Collusion
curve

7.5 10

15

30

Q2
20

10

II. Oligopoly
3.2. First Mover Advantage
Stackelberg Model

Assumptions
 One firm can set output first
 MC = 0
 Market demand is P = 30 - Q where Q is total
output
 Firm 1 sets output first and Firm 2 then makes
output decision seeing Firm 1s output
Firm 1
 Must consider reaction of Firm 2
Firm 2
 Takes Firm 1s output as fixed and therefore
determines output with Cournot reaction curve:
Q2 = 15 - (Q1)

3.2. First Mover Advantage

Stackelberg Model

Firm 1:

MR = MC = 0

Choose Q1 so that:

Firm 1 knows Firm 2 will choose output based

on its reaction curve.
Using Firm 2s reaction curve for Q2:
TR1 = 30Q1 Q12 Q1 (15 1 2Q1 )

TR1 = PQ1 = 30Q1 - Q12 - Q2Q1

= 15Q1 1 2 Q12
MR1 = TR1 Q1 = 15 Q1
MR = 0 : Q1 = 15 and Q2 = 7.5

Conclusions




Going first gives Firm 1 advantage

Firm 1s output twice as large as Firm 2s
Firm 1s profit twice as large as Firm 2s

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II. Oligopoly
3.3. Price Competition

Competition in oligopolistic industry
may occur with price instead of
output

Bertrand Model


Oligopoly model in which firms produce

homogeneous good, each firm treats
competitors prices as fixed, and all
firms decide simultaneously what price
to charge
23

3.3.Price Competition Bertrand

Model








Assumptions

Homogenous good

Market demand is P = 30 - Q where Q = Q1 + Q2

MC1 = MC2 = $3
Assume firms compete with price, not quantity
Since good is homogeneous, consumers buy from lowest
price seller

If firms charge same price, consumers indifferent who
they buy from
Both firms set price equal to MC

P = MC; P1 = P2 = $3

Q = 27; Q1 & Q2 = 13.5
Both firms earn zero profit
Why not charge different price?

If charge more, sell nothing

If charge less, lose money on each unit sold
Importance of strategic variable: Price versus output
24

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3.4.Price Competition
Differentiated Products

Market shares determined not just by prices,

but by design, performance, durability
Firms more likely to compete using price
instead of quantity
Example
 Duopoly with fixed costs of $20, but zero
variable costs
 Firms face same demand curves

Firm 1s demand: Q1 = 12 - 2P1 + P2

Firm 2s demand: Q2 = 12 - 2P2 + P1
 Quantity that each firm can sell decreases
when raises own price but increases when
competitor raises price
25

3.4. Price Competition

Differentiated Products

Firms set prices at same time

1 = P1Q1 20
= P1 (12 2 P1 + P2 ) 20
= 12 P1 - 2 P12 + P1 P2 20

If P2 is fixed:
Firm 1' s profit maximizing price :

1 P1 = 12 4 P1 + P2 = 0
Firm 1' s reaction curve : P1 = 3 + 1 4 P2
Firm 2' s reaction curve : P2 = 3 + 1 4 P1
26

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II. Oligopoly
P

3.5. A kinked
demand curve
Oligopolies prefer
fixed price and
quantity

MC1
MC2

P*
MR1

D1

MR2
Q*

D2
Q

14

II. Oligopoly
3.5. Game theory

A
Confess

Does not
confess

Confess

A: -5, B: - 5 A: - 10, B: 0

Does not
confess

A: 0, B: - 10 A: -2, B: -2

II. Oligopoly

3.6. Price leadership (Non-public

collusion)
-

Occurs when cartelization is illegal

One firm will act as leader and sets up price, the
others are followers
The leader must be strong enough to punish the
others, which do not follow his price, by pushing
the price to the lowest level so that that firm will
go bankruptcy

15

II. Oligopoly

4. Cartelized (public collusion):

-

Firms may merger and act as a

monopolist help reduce competing
cost
Cartel will agree about price and quantity,
then allocate quota for each member
Harmony among members is in top
priority
Transparency in information is importance
to avoid members fraudulent

II. Oligopoly
4. Cartelized (public collusion)
MC1
$ /u n it

MC2
MCT

Q1

Q0Q2 QT*

MR

16

OREC???

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