Lecture 5 - Oligopoly Flashcards
(21 cards)
What is an oligopoly?
A market structure with a small number of firms that have market power and make strategic decisions
What are the two main oligopoly models covered?
- Cournot model (simultaneous quantity-setting) 2. Stackelberg model (sequential quantity-setting)
What is the market demand function in these models?
Linear inverse demand: p = a - bQ where Q = q₁ + q₂ + … + qₙ
What is the cost structure assumed?
Constant marginal cost: TCᵢ = c·qᵢ for each firm
How is profit calculated for Firm 1 in Cournot model?
Π₁ = (a - b(q₁ + q₂))q₁ - cq₁ = (a - bq₂ - c)q₁ - bq₁²
What is a best response function?
The optimal quantity a firm should produce given the other firm’s quantity choice
What is Firm 1’s best response in Cournot model?
BR₁(q₂) = (a - bq₂ - c)/2b
How do you find Cournot Nash Equilibrium?
Solve the system of best response equations simultaneously
What are the equilibrium quantities in Cournot duopoly?
q₁* = q₂* = (a - c)/3b
What is the key difference in Stackelberg model?
Firms move sequentially: leader chooses first, follower observes and then chooses
What solution concept applies to Stackelberg model?
Subgame perfect Nash equilibrium (found via backward induction)
What is the follower’s best response in Stackelberg?
Same as Cournot: BR₂(q₁) = (a - bq₁ - c)/2b
How does leader choose quantity in Stackelberg?
Anticipates follower’s reaction and maximizes profit accordingly
What are equilibrium quantities in Stackelberg?
q₁* = (a-c)/2b (leader), q₂* = (a-c)/4b (follower)
What is first-mover advantage?
Leader earns higher profit in Stackelberg than in Cournot equilibrium
How does total output compare between models?
Stackelberg > Cournot > Cartel (monopoly output)
What happens as number of firms increases in Cournot?
Each firm’s quantity decreases: qᵢ* = (a-c)/(n+1)b
What is the cartel temptation in oligopoly?
Firms could earn monopoly profits by cooperating but have incentive to cheat
How do you solve three-firm sequential game?
- Solve Cournot between followers 2. Leader anticipates reaction 3. Backward induction
What are strategic substitutes?
When one firm increases output, the other’s best response is to decrease output
What is the key welfare implication?
Stackelberg has higher output (lower price) than Cournot, but still less than perfect competition
