Chapter 13
Oligopoly and Monopolistic
Competition
Key issues
1. market structure
2.game theory
3.cooperative oligopoly models (cartels)
4.Cournot model of noncooperative oligopoly
5. Stackelberg model of noncooperative oligopoly
6.monopolistic competition
7.Bertrand model of noncooperative oligopoly
Market structures
markets differ according to
• number of firms in market
• ease of entry and exit
• ability of firms to differentiate their
products
Oligopoly
• small group of firms in a market with substantial
barriers to entry
• because relatively few firms compete in such a
market,
• each firm faces a downward-sloping demand curve
• each firm can set its price: p > MC
• market failure: inefficient (too little) consumption
• each affects rival firms
• typical oligopolists differentiate their products
Monopolistic competition
• small or moderate number of firms
• free entry
• =0
• p = AC
• usually products differentiated
Strategies and games
• oligopolistic or monopolistically competitive firm
use a
• strategy:
• battle plan of actions (such as setting a price or
quantity) it will take to compete with other firms
• oligopolies engage in a
• game:
• any competition between players (such as firms) in
which strategic behavior plays a major role
Game theory
• set of tools used by economists, political
scientists, military analysts, and others to analyze
decision making by players (such as firms) who
use strategies
• these analytic tools can be used to analyze
• oligopolistic games
• poker
• coin-matching games
• tic-tac-toe
• elections
• nuclear war
Firm's objective
• obtain largest possible profit (or payoff) at
game’s end
• typically, one firm's gain comes at expense
of other firms
• each firm's profit depends on actions taken
by all firms
Nash equilibrium
• set of strategies is a Nash equilibrium if,
• holding strategies of all other players (firms) constant,
• no player (firm) can obtain a higher payoff (profit) by
choosing a different strategy
• in a Nash equilibrium, no firm wants to change its
strategy because each firm is using its
• best response:
• strategy that maximizes its profit given its beliefs about
its rivals' strategies
Duopoly
• consider single-period, duopoly, quantitysetting game
• duopoly: an oligopoly with two ("duo")
firms
Airlines Example
• American Airlines and United Airlines
• compete for customers on flights between
Chicago and Los Angeles
Notation
• Q = total number of passengers flown by
both firms; sum of:
• qA = passengers on American Airlines
• qU = passengers on United Airlines
Firms act simultaneously
• each firm selects a strategy that
• maximizes its profit
• given what it believes other firm will do
• firms are playing
• a noncooperative game of imperfect
information:
• each firm must choose an action before
observing rivals’ simultaneous actions
Dominant strategy
• a strategy that strictly dominates all other
strategies regardless of which actions rivals’
chose
• in this Table 13.2 game, each firm has a
dominant strategy
• firm chooses its dominant strategy
• where a firm has a dominant strategy, its
belief about its rival's behavior is irrelevant
Noncooperative game
• firms do not cooperate in a single-period
game
• In Nash equilibrium (qA = qU = 64), each
firm earns $4.1 million (< $4.6 million it
would make if firms restricted their outputs
to qA = qU = 48)
• sum of firms' profits is not maximized in
this simultaneous choice, one-period game
Why don't firms cooperate?
• don't cooperate due to a lack of trust:
• each firm can profitably use low-output
strategy only if it trusts other firm!
• each firm has a substantial profit incentive
to cheat on a collusive agreement
Prisoners' dilemma game
all players have dominant strategies that
lead to a profit (or other payoff) that is
inferior to what they could achieve if they
cooperated and played alternative strategies
Collusion in repeated games
• in a single-period prisoners' dilemma game,
firms produce more than they would if they
colluded
• why, then, are cartels frequently observed?
• collusion is more likely in a multiperiod
game: single-period game played repeatedly
• punishment: not possible in a single-period
game but possible in a multiperiod game
Supergame
• if a single-period game is played repeatedly, firms
engage in a
• supergame:
• players’ strategies in this period may depend on rivals'
actions in previous periods
• in a repeated game, firm can influence its rival's
behavior by
• signaling
• threatening to punish
Threat
• suppose American announces to United that
it will use the following two-part strategy:
• American produces smaller quantity each
period as long as United does the same
• if United produces larger quantity in period t,
then American will produce larger quantity in
period t + 1and all subsequent periods
• thus, if firms play same game indefinitely,
they should find it easier to collude
Know number of periods
• suppose firms know that they are going to play
game for T periods
• period T is like a single-period game, and all firms
cheat
• hence T-1 period is last interesting period
• by same reasoning, they cheat in that period, etc.
• cheating is less likely to occur if end period is
unknown or there is no end
Insurance price wars
• from 1984-1995, life insurance companies'
prices were high and unchanging
• in 1995, prices dropped 25% or more
Explanations for price war
1. insurers knew that new “Triple X” regulations
were expected to go into effect in 1996
• regulations required insurers to raise reserves on term
policies to cover future claims
• were expected to boost rates on new policies by as
much as 50%
• companies cut rates to attract new customers before
higher rates took effect
2. formal or informal agreement to keep prices high
fell apart as end of original game approached
Cooperative oligopoly models
Adam Smith:
"People of the same trade seldom meet
together, even for merriment and diversion,
but the conversation ends in a conspiracy
against the public, or some contrivance to
raise prices"
Cartels fail
luckily for consumers, cartels often fail
because
• each firm in a cartel has an incentive to
cheat on the cartel agreement by producing
extra output
• governments forbid them
Historic cartels
in late nineteenth century, cartels (trusts) were
legal and common in the United States
• oil
• railroads
• sugar
• tobacco
• steel
J.D. Rockefeller
Laws against cartels
• in response to trusts' high prices, Congress passed
• Sherman Antitrust Act in 1890
• Federal Trade Commission Act of 1914
• these laws prohibit firms from explicitly agreeing
to take actions that reduce competition, such as
jointly setting price
• these anti-cartel laws are called
• antitrust laws in U.S.
• competition policies in most other countries
Europe
• over the last dozen years, the European Commission has
been pursuing competition cases under laws that are
similar to U.S. antitrust laws
• recently the EC, the DOJ, and the FTC have become
increasingly aggressive, prosecuting many more cases
• following the U.S., which uses both civil and criminal
penalties, the British government introduced legislation in
2002 to criminalize certain cartel-related conduct
• EU uses only civil penalties, but its fines have increased
dramatically, as have U.S. fines
Corporate Leniency Program
• in 1993, DOJ introduced a new Corporate
Leniency Program that guarantees that participants
in cartels who blow the whistle will receive
immunity from federal prosecution
• as a consequence, DOJ has caught, prosecuted,
and fined several gigantic cartels (e.g. Vitamins)
• on Valentine’s Day, 2002, EC adopted a similar
policy
Sotheby’s and Christie’s
• Sotheby’s (established in 1744) and Christie’s
(1776) are the two largest and most prestigious
auction houses in the world
• they control 90% of the $4 billion worldwide
auction market
• for most of the last two and a half centuries, they
thrived
• starting at least by 1993, when faced with poor
business conditions, they started to collude,
according to the U.S. Department of Justice (DOJ)
Auctions (cont.)
• DOJ started investigating in 1997, but
gained the necessary evidence in 2000,
when Christie’s approached both DOJ and
European Commission with proof that it
had conspired with Sotheby’s to fix prices
• Christie’s applied for leniency under the
U.S. antitrust laws, effectively “shopping”
its rival
Auctions (cont.)
• DOJ charged that the pair
• held meetings between top-level executives
• exchanged confidential lists of super-rich clients
• agreed to limit which customers received lower
commissions
• charged identical commission rates (a sliding scale up
to 20%) to other sellers who had little negotiation
power
• Sotheby’s paid a $45 million fine
• the two auction houses agreed to pay more than
$512 million to former clients to settle lawsuits
Auctions (cont.)
• A. Alfred Taubman, Sotheby’s former chairman
and who still held a 21% share of stock and
controlled 63% of its voting rights, was sentenced
for price fixing to a year in prison and fined $7.5
million in 2002
• Christie’s former chairman, Sir Anthony Tennant,
lives in England has refused to come to the United
States to face trial
• however, days before Taubman’s conviction, the
European Commission brought charges against
both auction houses
Why some cartels persist
1. tacit collusion
2. international cartels (OPEC) and cartels
within certain countries operate legally
3. illegal cartel believes it can avoid detection
or punishment will be small
Why cartels form
members of cartel believe they can raise
their profits by coordinating their actions
Why can cartels raise profits?
• if a competitive firm is maximizing its
profit, why should joining a cartel increase
its profit?
• competitive firm is already choosing output to
maximize its profit
• however, it ignores effect that changing its
output level has on other firms' profits
• cartel takes into account how changes in
one firm's output affect cartel profits
Why cartels fail
• cartels fail if noncartel members can supply
consumers with large quantities of goods
(example: copper)
• each member of a cartel has an incentive to
cheat on cartel agreement
Figure 13.1 Competition Versus Cartel
(a) Firm
(b) Market
Price, p,
$ per unit
Price, p,
$ per unit
MC
S
pm
pm
AC
pc
pc
MC m
MCm
em
ec
Market demand
MR
q m q c q*
Quantity, q, Units
per year
Qm
Qc
Quantity, Q, Units
per year
Solved problem
• initially, all identical firms in a market
collude
• if some of these firms leave the cartel and
act like price takers, how are consumers
affected?
Maintaining cartels
to maintain cartel, firms must
• detect cheating
• punish violators
• keep its illegal behavior hidden from
governments
Detection and enforcement
• inspect each other's books (e.g., most-favored
nation clauses)
• governments report bids on
government contracts
• divide market by region or by customers
mercury cartel (1928-1972) allocated
U.S. to Spain and Europe to Italy
• use industry organizations to detect cheating
• offer "low price" guarantees
Insurance price wars
• life insurance companies' prices are
normally stable and high
• however, in 1995, companies dropped their
prices substantially: 25% or more
• the previous price war 1981-3, when term
insurance rates went from $4 to $1 per
thousand dollars of coverage for a 35-yearold for a 10-year plan
Cause of price war
• theory 1: sparked by new insurance regulations
• insurers knew in advance when these new regulations
(Triple X) were expected to go into effect
• new regulations required insurers raise reserves on term
policies to cover future claims; were expected to boost
rates by as much as 50%
• companies were cutting rates to attract new
customers before the higher rates took effect
Alternative theory
theory 2 (not necessarily incompatible
view): a formal or informal agreement to
keep prices high fell apart as the end of the
original game approached
Government created cartels
• American, European, and other governments
established a cartel in 1944 that fixed prices for
international airline flights and prevented
competition
• baseball teams exempted from some U.S. antitrust
laws since 1922
Bud Selig, baseball's commissioner:
“[The baseball] antitrust exemption is protection for the
fans.”
• automobiles
Automobile cartel
• Reagan admin. negotiated 1981 voluntary export
restraints (VER): Japanese auto manufacturers
would reduce their auto exports to U.S.
• Why would Japanese manufacturers “voluntarily”
reduce their exports?
• to avoid government quotas
• to act like a cartel: reducing sales to collusive level
• when U.S. allowed VER agreements to lapse in
1985, Japanese government wanted to continue to
restrict exports
Auto cartel effects
• stock market value of Japanese auto industry
increased during VER period by $6.6 billion
• VERs raised price of American cars by 5.4%
between 1981 and 1983
• U.S. consumers lost $6.9 billion ($1984) due to
these export restrictions
• using VER is foolish
• foreign and domestic auto manufacturers capture
“cartel” profits from higher prices
• tariffs better for U.S.
Entry and cartel success
• barriers to entry help cartel: limit competition
• cartels with large number of firms rare (except
professional associations)
• Dept. of Justice price-fixing cases 1963-1972
• only 6.5% involved 50 or more conspirators
• average number of firms was 7.25
• 48% involved 6 or fewer firms
• cartels often fall apart after entry (mercury)
Bail bonds
• Connecticut sets a maximum fee bail-bond
businesses can charge for posting a givensize bond
• how close price in a city is to legal
maximum depends on number of firms
# of active
firms
% of maximum
allowed fee
1
99
Meriden, New London
2
98
Norwalk
3
54
New Haven
8
64
Bridgeport
10
78
Town
Plainville, Stamford,
Wallingford
Mergers
• if antitrust or competition laws prevent
firms from colluding, they may try to merge
• U.S. laws restrict ability of firms to merge if
effect would be anticompetitive
Some mergers raise efficiency
• efficiency due to greater scale
• sharing trade secrets
• closing duplicative retail outlets
Chase and Chemical banks merged in 1995:
closed or combined 7 branches in Manhattan
located within 2 blocks of another branch
Airline mergers
• government did not contest most airline
mergers 1985-1988
• prices increased on routes served by firms
that merged relative to those on routes
without mergers
Soft drinks 1986 merger
proposals
• Coke, largest producer of carbonated soft drinks
(38.6% of sales), tried to buy third largest, Dr
Pepper (7.1%)
• Pepsi, second largest producer (27.4%), tried to
acquire fourth largest firm, Seven-Up Co. (6.3%)
• had these proposed mergers taken place, Coke's
market share would have risen to 45.7% and
Pepsi's to 33.7%
• combined share would have risen from 66.0% to
79.4%
FTC intervenes
•
•
•
•
Federal Trade Commission (FTC) opposed
mergers, arguing that merger
would increase market shares of big firms
make entry of new firms more difficult
raise costs of other companies doing
business in this market
ease "collusion among participants in the
relevant markets"
Relevant market definition
• Coca-Cola: all beverages including tap
water
• Federal Judge Gesell: carbonated soft drinks
(based on cross-elasticities of demand)
Outcome
• after Coke and Pepsi mergers blocked by FTC in
1986
• Dr Pepper Co. sold for $416 million to investor group
($54 million less than Coke offered)
• Seven-Up Co. sold for $240 million to another
investment group ($140 million less than Pepsico's bid)
• lower values to others than to Coke and Pepsi is
consistent with FTC's view that Coke and Pepsi
would have gained market power through these
mergers
Eventually
• Dr Pepper and Seven-Up merged
• by 1995: Dr Pepper/Seven-Up: 11.5% of carbonated
beverages market
• Cadbury: 5.5% [Schweppes, Canada Dry, Crush,
Sunkist, and A&W (root beer) brands]
• Cadbury bought Dr Pepper/Seven-Up (17% of softdrink market, and half non-cola part)
• Coke: 41%, Pepsi: 32%
• mergers increased share of top 3 firms
• FTC's actions limited share of top 2 firms
Noncooperative oligopoly
• many models of noncooperative oligopoly
behavior
• firms choose quantities
• Cournot model
• Stackelberg model
• firms set prices: Bertrand model
Cournot
• Augustin Cournot introduced first formal model of
oligopoly in 1838
• oligopoly firms choose how much to produce at
same time
• as in prisoners' dilemma game, firms are playing
noncooperative game of imperfect information
• each firm chooses its output level before knowing what
other firm will choose
• firms may choose any output level they want
Basic model
• duopoly: 2 firms (no other firms can enter)
• firms sell identical products
• market that lasts only 1 period (product or
service cannot be stored and sold later)
Cournot model of airline market
• duopoly: United Airlines (UA) and
American Airlines (AA) fly passengers
between Chicago and Los Angeles
• no possible entry (limited landing rights at
both airports)
Cournot equilibrium
• Nash equilibrium where firms choose
quantities
• set of quantities sold by firms such that,
holding quantities of all other firms
constant, no firm can obtain a higher profit
by choosing a different quantity
Figure 13.2a American Airlines’ Profit-Maximizing Output
(a) Monopoly
p, $ per
passenger
339
243
MC
147
MR
0
D
96
169.5
339
qA , Thousand American Airlines
passengers per quarter
Figure 13.2b American Airlines’ Profit-Maximizing Output
(b) Duopoly
p, $ per
passenger
339
275
211
MC
147
q U = 64
MR r
0
64
Dr
D
128 137.5
275 339
qA, Thousand American Airlines
passengers per quarter
Figure 13.3 American and United’s Best-Response Curves
q U , Thousand United
passengers per quarter
192
American’s best-response curve
96
Cournot equilibrium
64
48
United ’s best-response curve
0
64
96
192
q A, Thousand American
passengers per quarter
Figure 13.4a Duopoly Equilibria
(a) Equilibrium Quantities
qU, Thousand United
passengers per quarter
192
American’s best-response curve
96
Contract
curve
Price-taking equilibrium
Cournot equilibrium
64
Stackelberg equilibrium
48
Cartel
equilibrium
0
48
United’s best-response curve
64
96
192
q A , Thousand American passengers per quarter
Figure 13.4b Duopoly Equilibria
(b) Equilibrium Profits
U , $ million profit
of United Airlines
9.2
Profit possibility frontier
Cartel profits
4.6
4.1
Cournot profits
2.3
Stackelberg
profits
American monopoly
profit
Price-taking profits
0
4.1 4.6
9.2
A, $ million profit of American Airlines
Algebraic approach
• estimate of linear market demand function is
Q(p) = 339 – p
• linear residual demand facing AA is
qA = Q(p) – qU = (339 – p) – qU 
p = 339 - qA - qU
• slope of residual demand curve is p/qA = -1, so
slope of MRr = -2
MRr = 339 - 2qA - qU
Calculus
• linear residual demand facing AA is
p = 339 - qA – qU
• so AA’s revenue is
R = 339qA - qA2 - qUqA
• so AA’s marginal revenue (using the
Cournot assumption) is
MRr = dR/dqA = 339 – 2qA - qU
AA Maximizes profit
MRr = 339 - 2qA - qU = 147 = MC
 best-response function
qA = 96 - ½ qU
Cournot equilibrium
• intersection of best-response functions
qA = 96 - ½ qU
qU = 96 - ½ qA
• solve by substituting
qA = 96 - ½(96 - ½ qA)
 qA = 64
Q = qA + qU = 128
p = 339 – Q = $211
Solved problem
• Math version of Solved Problem 13.1 in text.
• Government charges American Airlines and
United Airlines a specific tax of  per passenger
on the Los Angeles-Chicago route.
• What is the new equilibrium number of passengers
that each airline flies?
• What's the equilibrium number if the tax is $30?
Answer
•
•
•
•
determine how the firms' best-response functions
change due to the tax:
AA sets its MRr equal to its MC (including the
tax)
MRr = 339 - 2qA - qU = 147 +  = MC
rearranging, AA’s best-response function is
qA = 96 - /2 - qU/2
similarly, UA's best-response function is
qU = 96 - /2 - qA/2
Answer (cont.)
•
•
•
solve for the equilibrium quantities in
terms of :
substitute UA's best-response function
into AA's and rearrange:
qA = (2/3)(96 – /2) = 64 – /3
substitute for qa in UA's best-response
function:
qU = 64 – /3
Answer (cont.)
solve for the equilibrium quantities where
= $30:
qA = qU = 64 – [1/3] = 54
European cigarette tax incidence
• As with a monopoly, an oligopoly may pass through less or
more than 100% of a tax to consumers
• Delipalla and O’Donnell’s (2001) estimate degree of passthrough to consumers from a specific tax on cigarettes:
• less than 100% in the Netherlands (67%), Belgium (79%), and
Germany (82%)
• about 100% in Denmark, the United Kingdom, Portugal, and
Ireland
• extremely high in Italy (359%), France (604%), and Luxembourg
(700%)
Cournot equilibrium varies with
number of firms
• typical Cournot firm maximizes its profit
MR = p(1 + 1/[n]) = MC
• n is elasticity of residual demand curve facing
each firm
•  is market elasticity of demand
• n is number of firms
• Lerner index:
p  MC
1

p
n
Air ticket prices and rivalry
• markup of price over marginal cost is much
greater on routes in which one airline carries most
of the passengers than on other routes
• a single firm is the only carrier or the dominate
carrier on 58% of all U.S. domestic routes
• monopoly serves 18% of all routes
• duopolies 19%
• three firms 16%
• four firms 13%
• five or more firms 35%
Air ticket prices (cont.)
• although nearly two-thirds of all routes have three
or more carriers, one or two firms dominate
virtually all routes
• dominant firm: has at least 60% of ticket sales by value
but is not a monopoly
• dominant pair if they collectively have at least 60% of
the market but neither firm is a dominant firm and three
or more firms fly this route
• all but 0.1% of routes have a monopoly (18%), a
dominant firm (40%), or a dominant pair (42%)
Air ticket prices (cont.)
• (average price includes “free” frequent flier tickets
and other below-cost tickets)
• ticket price is
• 2.1 x MC on average across all U.S. routes and market
structures
• 3.3 x MC for monopolies
• 3.1 x MC for dominant firms
• 1.2 x MC for dominant pairs
• if there is a dominant pair, whether there are 4 or 5
firms, price is between 1.3 x MC for a 4-firm route
and 1.4 x for a route with 5 or more firms
Stackelberg model
• Cournot model: both firms make their
output decisions simultaneously
• Heinrich von Stackelberg's model: firms act
sequentially
• leader firm sets its output first
• then its rival (follower) sets its output
Figure 13.5 Stackelberg Game Tree
Leader’s decision
Follower’s decision
48
Profits (A, U )
(4.6, 4.6)
48
United
64
(3.8, 5.1)
96
(2.3, 4.6)
48
(5.1, 3.8)
64
United
American
64
(4.1, 4.1)
96
(2.0, 3.1)
48
(4.6, 2.3)
96
United
64
(3.1, 2.0)
96
(0, 0)
Figure 13.6
Stackelberg Equilibrium
(a) Residual Demand American Faces
p, $ per
passenger
339
243
Dr
195
MR r
147
MC
q U = 48
D
0
qA = 96 Q = 144
(b) United ’s Best-Response Curve
192
339
q A, Thousand American passengers per quarter
qU, Thousand United
passengers per quarter
96
q U = 48
0
United ’s best-response curve
qA = 96
192
q A , Thousand American passengers per quarter
Question
• when firms move simultaneously,
• why doesn't AA announce it will produce
Stackelberg-leader output,
• so as to induce UA to produce the
Stackelberg follower's output level?
Answer
when firms move simultaneously, UA doesn't
view AA's warning that it will produce a large
quantity as a credible threat:
• not in AA’s best interest to produce large quantity
• because AA cannot be sure that UA believes threat
and reduce its output, AA produces Cournot level
• when one firm moves first, its threat to produce
large quantity is credible because it has already
committed to producing large quantity
Monopolistic competition
• market structure in which firms
• have market power
• are price setters
• firms enter if there is a profit opportunity ( = 0)
• monopolistically competitive equilibrium:
MR = MC
p = AC
(demand curve tangent to AC curve)
Figure 13.8 Monopolistically Competitive Equilibrium
p, $ per unit
AC
MC
p = AC
p
MR r = MC
MR r
q
Dr
q, Units per year
Figure 13.9a Monopolistic Competition Among Airlines
(a) Two Firms in the Market
p, $ per
passenger
if F = $2.3 million
300
275
 = $1.8 million
211
183
AC
MC
147
D r for 2 firms
MR r for 2 firms
0
64
137.5
275
q, Thousand passengers
per quarter
Figure 13.9b Monopolistic Competition Among Airlines
(b) Three Firms in the Market
p, $ per
passenger
300
243
195
AC
MC
147
D r for 3 firms
MR r for 3 firms
0
48
121.5
243
q, Thousand passengers
per quarter
Number of firms
• number of firms in equilibrium is smaller,
• greater economies of scale
• less market demand at each price
• fewer monopolistically competitive firms,
• less elastic is each firm’s residual demand curve
at equilibrium
• higher fixed cost
Fixed cost and number of firms
• fixed costs determine number of firms
AC = 147 + F/q
• smallest quantity at which AC curve reaches its
minimum called
• full capacity, or
• minimum efficient scale
• monopolistically competitive equilibrium in
downward-sloping section of AC curve, so
monopolistically competitive firm operates at less
than full capacity in LR
Bertrand
• firms set price instead of quantity
• changes equilibrium
• (unlike monopoly, choice of quantity vs.
price matters)
Figure 13.10 Bertrand Equilibrium with Identical Products
p 2, Price of Firm 2,
$ per unit
Firm 1’s best-response curve
10
Firm 2’s best-response curve
e
5
45° line
0
5
9.99 10
p 1, Price of Firm 1, $ per unit
Figure 13.11 Bertrand Equilibrium with Differentiated Products
pc , Price of Coke,
$ per unit
25
18
13
0
Pepsi ’s best-response
curve (MCp = $5)
Coke’s best-response
curve (MC c = $14.50)
e2
e1
13 14
Coke’s best-response
curve (MCc = $5)
25
pp , Price of Pepsi, $ per unit
1. Market structure
• prices, profits, and quantities in a market
equilibrium depend on the market's structure
• all firms maximize profit by setting MR = MC
• oligopolies and monopolistically competitive
firms are price setters: face downward-sloping
demand curves
• oligopoly: entry blocked
• monopolistic competition: free entry
2. Game theory
• set of tools used to analyze conflict and
cooperation between firms
• each firm forms a strategy or battle plan of the
actions to compete with other firms
• firms' set of strategies is a Nash equilibrium if,
• holding the strategies of all other firms constant,
• no firm can obtain a higher profit by choosing a
different strategy
3. Cooperative oligopoly models
• with collusion, firms collectively produce
monopoly output and earn monopoly profit
• each individual firm has an incentive to
cheat on a cartel arrangement so as to raise
its own profit even higher
4. Cournot model of
noncooperative oligopoly
• if oligopoly firms act independently, market
output and firms' profits lie between competitive
and monopoly levels
• Cournot model: each oligopoly firm sets its output
simultaneously
• Cournot (Nash) equilibrium: each firm produces
its best-response output given rivals’ outputs
• as number of Cournot firms increases, Cournot
equilibrium price, quantity, and profits approach
price-taking levels
5. Stackelberg model of
noncooperative oligopoly
• Stackelberg leader chooses its output first
• then its rivals - Stackelberg followers –
choose outputs
• leader produces more and earns a higher
profit than followers
6. Monopolistic competition
• monopolistically competitive firms are price
setters: MR= MC, so p > MC
• there's free entry: p = AC