MicroEcon 8

MicroEcon 8

1. Oligopoly

   • An oligopoly is a market with a small number of firms, linked by strategic interaction
     • First we describe Bertrand duopoly, in which the firms compete by setting prices
       • The two brands are perfect substitutes — no one can tell the difference. Each firm sets a price,… and then sells the quantity that consumers demand. In setting its price, each firm is concerned with the price that its competitor will set.
         • In a Bertrand duopoly, consumer demand is assumed to be perfectly inelastic. Each firm has a constant marginal cost and no fixed cost, so AC ≡ MC
           • The only equilibrium is 〈p, p〉, where each player cannot undercut the other, as they are charging the same price. In equilibrium, both firms have 0 profits because P = AC.
             • In the Bertrand game, a small number of firms producing the same product… …compete by setting prices. The equilibrium of the price-setting game is like the equilibrium of perfect competition: P = MC Social surplus is maximized. Economic profits are 0.
         • If the firms’ prices are different, consumers buy everything from the low-price firm, … and nothing from the high-price firm. If the firms’ prices are the same, consumers buy half their wine from each firm.
     • Then we model Cournot duopoly, in which the firms compete by setting output quantities.
       • The two brands are perfect substitutes — no one can tell the difference. Each firm decides how much to produce, and then sells its water at the market-clearing price.
         • In setting their quantities, each firm must consider how much the other firm is producing.
           • The market demand curve for a product is QD = 120 − P
             • If the market demand curve is a downward-sloping straight line, and MC is constant, then 2 Cournot competitors would produce a total of 2/3 of the efficient (competitive) level of output. 3 Cournot competitors would produce a total of 3/4 of the efficient (competitive) level of output. 99 Cournot competitors would produce a total of 99/100 of the efficient (competitive) level of output.
               • Conclusion: A very large number of Cournot competitors behave like perfect competitors and are almost efficient.

2. Does Bertrand or Cournot Make Sense?

   • Bertrand : In equilibrium, all firms charge AC, so each firm earns 0 profits. So firms would be no worse off by raising their prices, just in case the other firms do the same. Maybe all firms will coordinate on a price above MC. But there might be a tendency to cut prices afterwards
   • Cournot competition? If the price is greater than AC, why doesn’t one firm cut its price and take the whole market away from other firms? Perhaps there is fear of starting a price war. Maybe it’s better to let the market set prices. There are many variations of these models.

3. Monopolistic Conditions

   • Monopolistic competition describes a market in which firms produce differentiated products. These products are substitutes in consumption, but not perfect substitutes.
     • In the short run, monopolistically competitive firms behave like monopolies. Instead of producing as long as marginal cost is less than price (as in perfect competition), they produce only as long as marginal cost is less than marginal revenue (as a monopoly does).
       • But in the long run, monopolistic competition has free entry, much like perfect competition. Firms enter the market when economic profits are available, and exit when they are faced with losses. In long-run equilibrium, firms receive zero economic profits.
         • Monopolistic competitors do not interact strategically, because each firm cares only about the general price level, not about the strategies of individual firms.
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