Partial equilibrium
q
analysis:
y
Oligopoly
Lectures in Microeconomic Theory
Fall 2010, Part 18
07.07.2010

G.B. Asheim, ECON4230-35, #18
1
Examples
Telenor Mobil, NetCom
Rimi, Rema, others
SAS llow price
SAS,
i airlines
i li

Characteristica
Competition on price or quantity
Simultaneous or sequential decisions
H
Homogeneous
or diff
differentiated
i d products
d
One-time competition, or long-term relation
Competition from potential entrants
07.07.2010
G.B. Asheim, ECON4230-35, #18
2
1
Model
price
 2 ( y1, y2 )  p (Y ) y2
 a  b( y1  y2 )  y2
Inverse
demand fn.:
p (Y )  a  bY
y1
07.07.2010
y2
quantity
Y
3
G.B. Asheim, ECON4230-35, #18
No competition — Monopoly
P
p (Y m )
1 ( y1, y2 )   2 ( y1, y2 ) 
a  b( y1  y2 )  y1  a  b( y1  y2 )  y2
 a  bY Y
max a  bY Y
Y
FOC : a  2bY  0
Ym
Y
Y m  a / 2b

P (Y m )  a / 2

1 ( y1m , y2m )   2 ( y1m , y2m )  a  bY m Y m  a 2 / 4b
07.07.2010
G.B. Asheim, ECON4230-35, #18
4
2
Sequential quantity setting: Stackelberg
Firm 1 chooses quantity first (1 is the leader)
Firm 2 chooses quantity after having
observed firm 1’s
1 s quantity (2 is the follower)
p
Is it best to be a leader or a follower?
The follower' s problem :
max a  b( y1  y2 )  y2
y2
FOC : a  by
b 1  2by
b 2 0
Y
y1
y2  f 2 ( y1 )  (a  by1 ) / 2b
y2
07.07.2010
Firm 2' s best respo nse fn :
5
G.B. Asheim, ECON4230-35, #18
Stackelberg (cont.)
Τhe leader' s problem :
y2
The follower’s
best response fn
p


1
max a  b( y1  a 2by
b ) y1
y1
 max 12 a  by1  y1
y1
Iso profit curve FOC : a / 2  by  0
1
for the leader
y1

i.e., y1s  a / 2b

y2s  a  by2s / 2b  a / 4b
Y s  y1s  y2s  3a / 4b
p (Y s )  a / 4
Y 1 ( y1s , y2s )  p (Y s ) y1s  a 2 / 8b
y1
07.07.2010
y2
 2 ( y1s , y2s )  p (Y s ) y2s  a 2 / 16b
G.B. Asheim, ECON4230-35, #18
6
3
Simultaneous quantity setting: Cournot comp.
y2
Are there quantities for the two firms so that
no firm will regret its own quantity when told
of the quantity of the other firm?
1' s best respo nse fn : y1  ( a  by2 ) / 2b
2' s best respo nse fn : y2  (a  by1 ) / 2b
y1c  y2c  a / 3b
Y c  y1c  y2c  2a / 3b p (Y c )  a / 3
1 ( y1c , y2c )   2 ( y1c , y2c )  a 2 / 9b
y1
07.07.2010
A numerical example
y2
7
G.B. Asheim, ECON4230-35, #18
a  60 b  1
y1c  y2c  20
Y c  40 p (Y c )  20
 1 ( y1c , y2c )   2 ( y1c , y2c )  400
y1s  30 y2s  15
Y s  45 p (Y s )  15
 1 ( y1s , y2s )  450  2 ( y1s , y2s )  225
y1m  y2m  30
Y m  30 p (Y m )  30
 1 ( y1m , y2m ) 
y1
07.07.2010
G.B. Asheim, ECON4230-35, #18
 2 ( y1m , y2m )  900
8
4
Cournot competition with production costs
1 ( y1, y2 )  ( p (Y )  c1 ) y1  a  b( y1  y2 )  c1  y1
y2
 2 ( y1, y2 )  ( p (Y )  c2 ) y2  a  b( y1  y2 )  c2  y2
FOC : y1  a  by2  c1  / 2b
y2  a  by1  c2  / 2b
Firm 1’s best
response fn
y1c  (a  c2  2c1 ) / 3b
y2c  (a  c1  2c2 ) / 3b
Firm 2’s best
response fn
f
What happens if firm 1’s
costs are reduced?
y1
07.07.2010
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G.B. Asheim, ECON4230-35, #18
Observations about Cournot competition

Best response curves have negative slope

Cournot s ”reaction
Cournot’s
reaction
story” is stabile.
Reduced c shifts 1’s
curve outwards.


1
Reduced c leads to
increased y and reduced y .
1
1

yy22
yy11
2
Reduced c leads to a direct and indirect advantage
for 1 and an indirect disadvantage for 2.
07.07.2010
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G.B. Asheim, ECON4230-35, #18
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5
General analysis of Cournot competition
p (Y ) where Y  y1  y2 ( Homogeneous products)
 i ( yi , y j )  p ( yi  y j ) yi  ci ( yi )
FOC :
 i
 p (Y )  p(Y ) yi  ci ( yi )  0
yi
p (Y )  ci ( yi )
y
Y yi
s
  p(Y ) i   p(Y )
 i
p (Y )
p (Y )
p (Y ) Y

y
where si  i is i' s market share,
Y
1 p (Y )
and  
is the elasticity of demand.
p(Y ) Y
07.07.2010
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G.B. Asheim, ECON4230-35, #18
Characterization of Cournot competition
marginal revenue

Each firm has market power (P(Y)  P(Y)  P(Y) y )

Outcome lies between monopoly and perfect comp.

Difference between price and marginal cost is
reduced when the demand becomes more elastic.

Each firm’s difference between price and marginal
cost is proportional to its market share.

A firm’s market share depends of its efficiency.

Even less efficient firms ”survive” with positive
market share.
i
07.07.2010
G.B. Asheim, ECON4230-35, #18
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6
Cournot competition with many firms
Assume ci ( yi )  c for all firms and quantities .
p (Y )  c
1

 perfect competitio n when n  .
p (Y )
n
p u (Y )
Welfare analysis of Cournot comp.
Firms act as if they maximize
1
n
 p(Y )Y  cY   nn1 u (Y )  cY  where
u (Y )  
n  1 : Monopol y, maximize profit.
n  " large" : Almost maximize welfare.
07.07.2010
G.B. Asheim, ECON4230-35, #18
Y
0
~
p (Y )
~
Y Y
~ ~
p (Y )dY
13
Condition for decreasing best response fn.
Profit function :  i ( yi , y j )
 i ( f i ( y j ), y j )
Best response fn : f i ( y j ) defined by
0
yi
2
2
 i
 i
Differenti ate totally :
dyi 
dy j  0
2
yi y j
yi
SOC for
 2 i
-max.
yi y j
dyi
 2 i
 2 i
f i( y j ) 
 2
 0 if

0
&
0
dy j  i 0
yi y j
 i
yi2
yi
yi2
f i( y j )  0 : Strat. substitutes f i( y j )  0 : Strat. complem.
07.07.2010
G.B. Asheim, ECON4230-35, #18
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7
Simultaneous price setting: Bertrand comp.
Inverse demandfn.: p (Y )  a  bY
No costs.
The firm with the lowest price gets all the demand.
(If both
b h set the
h same price,
i then
h each
h gets h
half
lf the
h ddemand.)
d)
Are there prices such that no firm will regret its own price
when told of the price of the other firm?
p1  p2  MC  0 ?
Each firm will regret that it did not set a lower price.
p1  p2  MC  0 eller p2  p1  MC  0 ?
The lower price firm will regret not having set a higher price.
Hence: p1b  p2b  MC  0
07.07.2010
y1b  y2b  a / 2b
G.B. Asheim, ECON4230-35, #18
 1b   2b  0
15
Observation
Firms in oligopoly markets set prices, but the competition
does not seem to be as hard as under perfect competition.
Why not?
1. There are capacity constraints. The Cournot model
can be interpreted as competition in capacity
(Example: Competition between tour operators)
2. Long-term relation. If one firm sets a lower price now,
then competitors will set lower prices in future
periods. (Example: Meet-the-competition-clause)
3. The products are differentiated. Types of differentiation.
(Example: Advantage programs for loyal customers)
07.07.2010
G.B. Asheim, ECON4230-35, #18
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8