Oligopoly Flashcards
What are the conditions for Oligopoly?
- Relatively few firms (
What are two key causes of oligopolies?
- High barriers to entry in the market (for example, huge fixed costs in airplane industry).
- Significant economies to scale in the market.
Explain the rationality behind the Sweezy oligopoly model?
- When a firm drops it price, the model assumes rival firms will also drop prices, in order not to lose significant market share.
- However, when a firm increases its prices, the model assumes rival firms won’t match the price rise.
This leads to a kinked demand curve.
What is the key feature of the Sweezy model?
- Leads to price rigidity. This is because there is a discontinuity in the MR curve, meaning that there can be a range of MC where price will stay exactly the same.
(Assumes firms profit maximise where MC=MR.)
What are the key assumptions of the Cournot model?
- Few firms, each producing homogenous or differentiated goods.
- Firms compete on output (output is the strategic variable)
- Each firm believes that the other firm will hold output constant if it changes its own output.
- Significant barriers to entry.
What is a best response function?
A schedule, summarising a firms profit maximising output level for each quantity produced by its rival.
How do we find a firms best-response function?
- Simply equate its MC with MR, and solve for its output as a function of its rival’s output.
Where is the Cournot Equilibrium?
Equilibrium in Cournot model exists where the two firm’s best response functions cross. At this point, each firm is producing an output that maximises its profits, given the output of rival firms.
What is the effect of a rise in costs for one firm under a Cournot model?
- Leads to a parallel shift in firm’s best response function, towards the origin! The net effect is that the firm suffering increased costs will lose market share at the expense of its rival. (Show on diagram).
Is there an incentive to collude under Cournot model?
YES! If both firms jointly produce the monopoly level of output, collusion can bring about higher profits for both firms (show on diagram).
Is there an incentive to cheat on a collusive agreement under Cournot?
YES! One firm can produce a higher level of output, taking market share from its rival, and producing on a lower isoprofit curve. (Show this on a diagram).
What are the assumptions of a Bertrand oligopoly model?
- Few firms in the market.
- Barrier to entry exist.
- Firms produce homogenous or differentiated product.
- Output still the decision variable.
- KEY DIFFERENCE: One firm is the leader.
- Remaining firms follow after leader chooses output.
What are the key conclusions of Stackelberg model?
- Commitment can enhance the profits of the leader in strategic environments.
- Leader produces more than he would under Cournot. (This is due to FIRST MOVER ADVANTAGE)
- Follower has to produce less, receiving smaller profits.
What are the assumptions of the Bertrand oligopoly model?
- Few firms selling to many consumers.
- Firms produce identical products at constant marginal cost.
- Price is decision variable (both firms look to profit maximise.)
- Consumers have perfect information, and face zero transaction costs.
Explain the Bertrand equilibrium?
- Firms will both sell at the same price, which is equal to their marginal cost.
Why? If one firm undercuts another, they will capture the entire market! Thus, price war will ensue until both firms are earning only normal profits.
