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Chapter 12

Chapter 12. Imperfect Competition. The profit-maximizing output for the monopoly. Price, Cost. c. b. MC. AC. d. a. Quantity. 0. MR. D. If there are no other market entrants, the entrepreneur can earn monopoly profits that are equal to the area dcba. Chapter Preview.

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Chapter 12

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  1. Chapter 12 Imperfect Competition

  2. The profit-maximizing output for the monopoly Price, Cost c b MC AC d a Quantity 0 MR D If there are no other market entrants, the entrepreneur can earn monopoly profits that are equal to the area dcba.

  3. Chapter Preview • Most markets fall in between perfect competition and monopoly. • An oligopoly is a market with only a few firms, and their behavior is interdependent. • There is no one oligopoly model. In general we want to consider: • Short run: pricing and output decision of the firms. • Long run: advertising, product development. • Very long run: entry and exit.

  4. Pricing of Homogeneous Products: An Overview Price Monopoly and the perfect cartel outcome. Cournot outcome (firms choose output). PM Perfect competition and the Bertrand model (firms choose prices). MC = AC PPC D MR QM QPC Quantity per week

  5. Pricing of Homogeneous Products: An Overview • So in an oligopoly there can be a variety of outcomes: • If the firms act as a cartel, get the monopoly solution. • If the firms choose prices simultaneously, get the competitive solution. • If the firms choose output simultaneously get some outcome between perfect competition and monopoly.

  6. Cournot Theory of Duopoly & Oligopoly • Cournot model • Two firms • Choose quantity simultaneously • Price - determined on the market • Cournot equilibrium • Nash equilibrium

  7. The demand curve facing firm 1 Price, Cost P=A-b(q1+q2) A-bq2’ A MC MR1 MR2 A-bq2 MRM D2(q1,q2’) D1(q1,q2) Quantity 0 DM(q1) q12 qM q11 q1 declines as firm 2 enters the market and expands its output

  8. Profit Maximization in a duopoly market • Inverse demand function – linear P=A-b(q1+q2) • Maximize profits π1= [A-b(q1+q2)]·q1 - C(q1) π2= [A-b(q1+q2)]·q2 - C(q2)

  9. Reaction functions (best-response) • Profit maximization: • Set MR=MC • MR now depends on the output of the competing firm • Setting MR1=MC1 gives a reaction function for firm 1 • Gives firm 1’s output as a function of firm 2’s output

  10. Reaction functions (best-response) Output of firm 2 (q2) q1=f1(q2) Output of firm 1 (q1) 0 Given firm 2’s choice of q2, firm 1’s optimal response is q1=f1(q2).

  11. Reaction Functions • Points on reaction function • Optimal/profit-maximizing choice/output • Of one firm • To a possible output level – other firm • Reaction functions • q1= f1(q2) • q2 = f2(q1)

  12. Reaction functions (best-response) Output of firm 2 (q2) q2=f2(q1) Output of firm 1 (q1) 0 Given firm 1’s choice of q1, firm 2’s optimal response is q2=f2(q1).

  13. Alternative Derivation -Reaction Functions • Isoprofit curves • Combination of q1 and q2 that yield same profit • Reaction function (firm 1) • Different output levels – firm 2 • Tangency points – firm 1

  14. Reaction Function Output of firm 2 (q2) y x Firm 1’s Reaction Function q2 q1 q’2 Output of firm 1 (q1) 0 q1m q’1

  15. Deriving a Cournot Equilibrium • Cournot equilibrium • Intersection of the two Reaction functions • Same graph

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