Ch27-Oligopoly.ppt

Chapter Twenty-Seven,Oligopoly,Oligopoly,A monopoly is an industry consisting a single firm.A duopoly is an industry consisting of two firms.An oligopoly is an industry consisting of a few firms.Particularly,each firms own price or output decisions affect its competitors profits.,Oligopoly,How do we analyze markets in which the supplying industry is oligopolistic?Consider the duopolistic case of two firms supplying the same product.,Quantity Competition,Assume that firms compete by choosing output levels.If firm 1 produces y1 units and firm 2 produces y2 units then total quantity supplied is y1+y2.The market price will be p(y1+y2).The firms total cost functions are c1(y1)and c2(y2).,Quantity Competition,Suppose firm 1 takes firm 2s output level choice y2 as given.Then firm 1 sees its profit function asGiven y2,what output level y1 maximizes firm 1s profit?,Quantity Competition;An Example,Suppose that the market inverse demand function isand that the firms total cost functions are,and,Quantity Competition;An Example,Then,for given y2,firm 1s profit function is,Quantity Competition;An Example,Then,for given y2,firm 1s profit function is,So,given y2,firm 1s profit-maximizingoutput level solves,Quantity Competition;An Example,Then,for given y2,firm 1s profit function is,So,given y2,firm 1s profit-maximizingoutput level solves,I.e.firm 1s best response to y2 is,Quantity Competition;An Example,y2,y1,60,15,Firm 1s“reaction curve”,Quantity Competition;An Example,Similarly,given y1,firm 2s profit function is,Quantity Competition;An Example,Similarly,given y1,firm 2s profit function is,So,given y1,firm 2s profit-maximizingoutput level solves,Quantity Competition;An Example,Similarly,given y1,firm 2s profit function is,So,given y1,firm 2s profit-maximizingoutput level solves,I.e.firm 1s best response to y2 is,Quantity Competition;An Example,y2,y1,Firm 2s“reaction curve”,45/4,45,Quantity Competition;An Example,An equilibrium is when each firms output level is a best response to the other firms output level,for then neither wants to deviate from its output level.A pair of output levels(y1*,y2*)is a Cournot-Nash equilibrium if,and,Quantity Competition;An Example,and,Quantity Competition;An Example,and,Substitute for y2*to get,Quantity Competition;An Example,and,Substitute for y2*to get,Quantity Competition;An Example,and,Substitute for y2*to get,Hence,Quantity Competition;An Example,and,Substitute for y2*to get,Hence,So the Cournot-Nash equilibrium is,Quantity Competition;An Example,y2,y1,Firm 2s“reaction curve”,60,15,Firm 1s“reaction curve”,45/4,45,Quantity Competition;An Example,y2,y1,Firm 2s“reaction curve”,48,60,Firm 1s“reaction curve”,8,13,Cournot-Nash equilibrium,Quantity Competition,Generally,given firm 2s chosen outputlevel y2,firm 1s profit function is,and the profit-maximizing value of y1 solves,The solution,y1=R1(y2),is firm 1s Cournot-Nash reaction to y2.,Quantity Competition,Similarly,given firm 1s chosen outputlevel y1,firm 2s profit function is,and the profit-maximizing value of y2 solves,The solution,y2=R2(y1),is firm 2s Cournot-Nash reaction to y1.,Quantity Competition,y2,y1,Firm 1s“reaction curve”,Firm 1s“reaction curve”,Cournot-Nash equilibriumy1*=R1(y2*)and y2*=R2(y1*),Iso-Profit Curves,For firm 1,an iso-profit curve contains all the output pairs(y1,y2)giving firm 1 the same profit level P1.What do iso-profit curves look like?,y2,y1,Iso-Profit Curves for Firm 1,With y1 fixed,firm 1s profitincreases as y2 decreases.,y2,y1,Increasing profitfor firm 1.,Iso-Profit Curves for Firm 1,y2,y1,Iso-Profit Curves for Firm 1,Q:Firm 2 chooses y2=y2.Where along the line y2=y2 is the output level thatmaximizes firm 1s profit?,y2,y2,y1,Iso-Profit Curves for Firm 1,Q:Firm 2 chooses y2=y2.Where along the line y2=y2 is the output level thatmaximizes firm 1s profit?A:The point attaining thehighest iso-profit curve for firm 1.,y2,y1,y2,y1,Iso-Profit Curves for Firm 1,Q:Firm 2 chooses y2=y2.Where along the line y2=y2 is the output level thatmaximizes firm 1s profit?A:The point attaining thehighest iso-profit curve for firm 1.y1 is firm 1s best response to y2=y2.,y2,y1,y2,y1,Iso-Profit Curves for Firm 1,Q:Firm 2 chooses y2=y2.Where along the line y2=y2 is the output level thatmaximizes firm 1s profit?A:The point attaining thehighest iso-profit curve for firm 1.y1 is firm 1s best response to y2=y2.,y2,R1(y2),y2,y1,y2,R1(y2),y2”,R1(y2”),Iso-Profit Curves for Firm 1,y2,y1,y2,y2”,R1(y2”),R1(y2),