Introduction:
- Oligopoly is where there are a few large firms in the market and as the firms are large
relative to the market they respond strategically to each other
- Contemporary oligopoly models can be either price (Bertrand) or quantity setting (Cournot)
- Briefly explain principle of either Bertrand or Cournot model whichever applies: firms decide
how much output to produce/price to set as strategic variable
- Market structure:
1. Few large firms: seller is large enough to affect market price and the few rivals are large
as they respond strategically to changes in seller’s output
2. High barriers to entry: large firms persist over time as hard to enter
3. Product substitutability can be undifferentiated or differentiated: doesn’t affect market
power of the seller as this power stems from there being only a few large firms in the
market and entry barriers being high
Main Body:
- Assumptions of Oligopoly:
1. Buyers are price takers
2. Buyers and Sellers have complete info
3. Sellers are price makers: seller can influence the price when it sells output; seller sells
more when price is lower and hence we get a -ve sloped D curve as well as the seller’s
output choice triggering a reaction in rivals; previously in monopolistic competition
there was no reaction and this is because there are lots of sellers in that structure so
can’t react to every change. However with few large firms there is a reaction to change
in output.
4. Entry is blocked: no entry into market even in long run
- Cournot model specific assumptions:
1. 2 sellers A+B in a market: they are duopolists who choose the level of output they
produce (hence output is strategic variable) and make output decisions simultaneously
2. Further entry to the market is completely blocked
3. Firms produce homogeneous products; products which are identical
4. Market demand is P = a – Q ; a>0 and Q is total market output; this means that as firms
produce more the market price will go down and hence the demand curve is downward
sloping
- Due to us assuming the market is a duopoly in 1. The market demand is P = a – Qa – Qb
where Qa and Qb are output of firm A and B respectively
- We can use the Nash equilibrium concept to solve this game to see how firms behave under
these assumptions
- There is a Nash equilibrium when no firm wants to change its output holding the other firms
output level constant:
- Nash equilibrium made up of 2 output levels Qa* and Qb* which are A and B’s equilibrium
output levels such that
- Given A produces Qa*, B maximises profit by producing
Qb* and vice versa
- Both firms are playing their best responses in terms of
output choice while considering each other’s output
choices as part of the decision
- Cournot Nash Equilibrium Diagram (on left)
- Oligopoly is where there are a few large firms in the market and as the firms are large
relative to the market they respond strategically to each other
- Contemporary oligopoly models can be either price (Bertrand) or quantity setting (Cournot)
- Briefly explain principle of either Bertrand or Cournot model whichever applies: firms decide
how much output to produce/price to set as strategic variable
- Market structure:
1. Few large firms: seller is large enough to affect market price and the few rivals are large
as they respond strategically to changes in seller’s output
2. High barriers to entry: large firms persist over time as hard to enter
3. Product substitutability can be undifferentiated or differentiated: doesn’t affect market
power of the seller as this power stems from there being only a few large firms in the
market and entry barriers being high
Main Body:
- Assumptions of Oligopoly:
1. Buyers are price takers
2. Buyers and Sellers have complete info
3. Sellers are price makers: seller can influence the price when it sells output; seller sells
more when price is lower and hence we get a -ve sloped D curve as well as the seller’s
output choice triggering a reaction in rivals; previously in monopolistic competition
there was no reaction and this is because there are lots of sellers in that structure so
can’t react to every change. However with few large firms there is a reaction to change
in output.
4. Entry is blocked: no entry into market even in long run
- Cournot model specific assumptions:
1. 2 sellers A+B in a market: they are duopolists who choose the level of output they
produce (hence output is strategic variable) and make output decisions simultaneously
2. Further entry to the market is completely blocked
3. Firms produce homogeneous products; products which are identical
4. Market demand is P = a – Q ; a>0 and Q is total market output; this means that as firms
produce more the market price will go down and hence the demand curve is downward
sloping
- Due to us assuming the market is a duopoly in 1. The market demand is P = a – Qa – Qb
where Qa and Qb are output of firm A and B respectively
- We can use the Nash equilibrium concept to solve this game to see how firms behave under
these assumptions
- There is a Nash equilibrium when no firm wants to change its output holding the other firms
output level constant:
- Nash equilibrium made up of 2 output levels Qa* and Qb* which are A and B’s equilibrium
output levels such that
- Given A produces Qa*, B maximises profit by producing
Qb* and vice versa
- Both firms are playing their best responses in terms of
output choice while considering each other’s output
choices as part of the decision
- Cournot Nash Equilibrium Diagram (on left)
