3. Learning Objectives
• After studying this chapter you will be able to:
• Explain how strategic interaction shape optimal decisions in
oligopoly market
• Identify the conditions of oligopoly and explain how different types
of oligopoly makes price decisions, output decisions, and firm
profits
• Identify the conditions for competitive market and explain market
power and sustainability of long run profits.
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4. Introduction
• An oligopolistic market structure describes the situation
where a few firms dominate the industry
• Managers select the optimal price and quantity in the
following oligopoly market environments:
• Sweezy
• Cournot
• Stackelberg
• Bertrand
• For more information on “Oligopolies and Game Theory”:
• https://www.youtube.com/watch?v=JMq059SAQXM
• For more information on “Oligopolies, duopolies,
collusion, and cartels”
• https://www.youtube.com/watch?v=N0L00FZnhtg&list=PLNz8UZHL3nk5w5ENxAigU1MCW3AXVMNrY
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5. Key Conditions ofOligopoly
• The main conditions for oligopoly to exist are as follows:
1. A relatively small number of firms account for the
majority of the market. Typical number of firms is
between 2 and 20.
2. There are significant barriers to entry and exit.
3. There is an interdependence in decision-making.
Products can be identical or differentiated.
Oligopoly settings tend to be the most difficult to
manage since managers must consider the likely impact
of decisions of other firms in the market.
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6. Oligopoly Strategy: PriceChange
Response
Price
C
Optimal decision on price will depend on how the
manager believes other managers will respond.
Demand if rivals
match price changes
Output0
Demand2
Demand1
A
B
Demand if rivals do not
match price changes
9. Oligopoly Market Environments
• Oligopoly market environments:
• Sweezy
• Cournot
• Stackelberg
• Bertrand
• For more information on “The Different Types of
Oligopoly”
• https://www.youtube.com/watch?v=BqAvQWIilqk
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10. Conditions for SweezyOligopoly
• There are few firms in the market serving many
consumers.
• The firms produce differentiated products.
• Each firm believes its rivals will cut their prices in
response to a price reduction but will not raise their
prices in response to a price increase.
• Barriers to entry exist.
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11. Conditions for CournotOligopoly
• There are few firms in the market serving many
consumers.
• The firms produce either differentiated or
similar products.
• Each firm believes that their rivals will not
change their output if it changes its output.
• Barriers to entry exist.
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12. Cournot Oligopoly: Reaction
Functions
• Each firm makes an output decision assuming that rival
will hold its output constant when the other changes its
output level.
• Marginal revenue of one firm is impacted by other firms
output decision.
• Firm’s profit-maximizing output level is called a best-
response or reaction function.
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14. Cournot Oligopoly: Collusion
• Collusion: A few dominant firms can negotiate to restrict
output to charge higher prices in the market.
• Collusion, however, is prone to cheating behavior.
• Since both parties are aware of these incentives, reaching collusive
agreements is often very difficult.
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15. Incentive to Collude in aCournot
Oligopoly
Quantity2
Collusion outcome
Quantity1
16. Conditions for Stackelberg
Oligopoly
• There are few firms serving many consumers.
• Firms produce either differentiated or homogeneous
products.
• Leader and follower firms: the leader (single firm) chooses
an output before all other firms choose their outputs.
• The followers (all other firms) take as given the output of
the leader and choose outputs that maximize profits given
the leader’s output.
• Barriers to entry exist.
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18. Conditions for BertrandOligopoly
• There are few firms in the market serving many
consumers.
• Firms produce identical products at a constant marginal
cost.
• Firms involve in price competition and react optimally to
prices charged by competitors.
• Consumers have perfect information and there are no
transaction costs.
• Barriers to entry exist.
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20. Contestable markets: Key
Conditions
• Contestable markets have strategic interaction among
existing firms and potential new firms enter into a
market.
• A market is contestable if:
• All producers have access to the same technology.
• Consumers respond quickly to price changes.
• Existing firms cannot respond quickly to entry by
lowering price.
• There are no sunk costs.
• Therefore, incumbent firms have no market power over
consumers.
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