Strategic Thinking in an Oligopoly

Strategic Thinking in an Oligopoly
Presented by:

Michael Chai
CA(M), CPA, CFP, MCSM, MMIM
1

Oligopolistic concepts/issues:
– Duopoly strategic interaction – Cournot Equilibrium – Kinked demand curve – Cartel instability

2

Cournot Model
• Interdependence between firms • Max π given what one firm believes the other will produce • Decisions made simultaneously • Firms compete on non-price techniques • Simplest model is a duopoly

3

Numerical example – Duopoly
• • • • Assume market demand is represented by: P = 30 – Q where Q = Q1 + Q2 Assume Q1 = Q2 Assume AC = MC = 12 (implies zero Fixed Cost)

4

From Firm 1’s perspective P 30
If Firm 1 believes Firm 2 will produce entire market demand (Q=18), it will produce zero If Firm 1 believes Firm 2 will produce zero, it will act like a monopolist & produce 9 units & set monopolist P = $21

21

12

MC = AC

MR 0 9 15 18

D 30 Q
5

From Firm 2’s perspective P 30
If Firm 2 believes Firm 1 will produce entire market demand (Q=18), it will produce zero If Firm 2 believes Firm 1 will produce zero, it will act like a monopolist & produce 9 units & set monopolist P = $21

21

12

MC = AC

MR 0 9 15 18

D 30 Q
6

Q1
18

If Firm 1 believes Firm 2 will produce Q2=18, it will produce Q1=0 Firm 2’s Reaction Curve Q2 = 9 – 0.5Q1 Competitive Equilibrium Cournot Equilibrium

If Firm 1 believes Firm 2 will produce Q2=0, it will produce Q1=9

9 Collusive Equilibrium 6 4.5 Firm 1’s Reaction Curve Q1 = 9 – 0.5Q2

4.5 6

9

18

Q2
7

P 30

Cournot Equilibrium compared using a traditional Monopoly diagram

Under Monopoly: Welfare Loss is ABC

21 18 15 12 C

A E G

Under 2 Firm Cournot : Welfare Loss is EFB

Under PC: No Welfare Loss

B F H

MC = AC

MR 0 9 12 15 18

D 30 Q
8

• • • • • • •

Under Perfect Competition; P = 12, Q = 18 (No welfare loss) Under Monopoly; P = 21, Q = 9 (Welfare loss is ABC) Under 2 Firm Cournot; P = 18, Q = 12