Models of Competition
Part IIIb: Other Oligopoly Models &
Monopolistic Competition
Agenda:
1. Cornot gnome problem answers
2. Other Oligopoly Models
A. Stackelberg – first mover advantage
B. Bertrand – choose price
3. Monopolistic Competition
A. Assumptions
B. Short term
C. Long-term – the price of diversity!
4. Conclusion: A continuum of competition!
Example: Garden Gnomes…AGAIN!
Another firm manages to come up with different technology that also
makes Garden Gnomes absorb CO2 and combat global warming.
They have a patent too, and conveniently the same cost structure as
you. So now the market is a duopoly. (Round Q to nearest whole #)
Market demand: QD = 6500 -100P or P = 65 – Q/100
FIRM total cost:
C(q) = 722 + q2/200
FRIM marginal cost:
MC(q) = 2q/200 = q/100
NOTE q = Q1 or Q2 depending on which firm you’re thinking about!
1. What is the Marginal Revenue for Firm #1?
P = 65 – 2Q1/100 – Q2/100
2. What is the response function for Q1 (an expression for Q1 in
terms of Q2)? HINT: remember, if in doubt try MR = MC!
6500  Q2
3
 6500  Q1 
6500  

3


Q1 
3
Q1  1626
Q1 
3. How much does Q1 produce? HINT:
remember there is symmetry in the
response functions since both firms have
the same cost structure.
MR  MC
65 
2Q1 Q2
Q

 1
100 100 100
Q
3Q
65  2  1
100 100
6500  Q2
 Q1
3
4. What is the equilibrium price and quantity for the
market?
Q = 2*1626=3,252 P = $32.48
Oligopoly: The Stackelberg Model
Firm #1 (leader) knows that firm #2 (follower) will take firm
#1’s quantity as given following the Cournout model…
Demand Function
P  a  b  Q1  Q2 
Heinrich Freiherr von Stackelberg
1905 - 1946
a  bQ1  Substitute firm #2’s

 a  b  Q1 
 response function
2b  assuming MC = 0

What is Firm #1’s
 a  bQ1 
Marginal Revenue Function?
 a  bQ1  

 2 
a
bQ

1
2a a 2bQ1  bQ1
MR   2 


 
2
2


2 2
2
a
a  bQ1
Firm #1
MR


bQ
P
1
Demand Function
2
2
Oligopoly: The Stackelberg Model Continued
What is on the X and Y axis?
What kind of functions are graphed?
First mover produces the same
quantity as a pure monopolist
Cournot equilibrium
As long as second mover doesn’t respond
and push the equilibrium to Cournot
How is Stackelberg different from Cournot?
First Mover Advantage!!
Oligopoly: The Bertrand Model
Firms choose price and the market sets quantity
Each firm takes the other’s price as given
Firm #1
Firm #2
Lower
Price
Lower
Price
Same
Price
Higher
Price
Same
Price
Higher
Price
all
all
half
all
nothing
all
all
half
half
half
nothing
all
half
nothing nothing
half
nothing
nothing
Joseph Louis François Bertrand
(1822 – 1900)
Price set at MC
Same as
perfect competition!
Collusion
Cartels
Dynamic games
Monopolistic Competition: The Chamberlin Model
Key features:
 Many firms
 Free entry and exit
 Symmetry – what’s good for one is
good for the others equally
X Differentiated products make
imperfect substitutes
Edward Chamberlin
Joan Robinson
A matter of degree….
Monopolistic Competition in the History of Economic Thought
http://ccso.eldoc.ub.rug.nl/FILES/root/2002/200215/200215.pdf
Monopolistic Competition: The Short Run
Short Run
Joan Robinson
Market demand curve
Which is more ELASTIC?
Firm demand curve
P2
Q2
Entry of close substitutes
Is this firm making a producer surplus?
Is this firm making a profit?
What will happen in the long run?
Monopolistic Competition: Long-run Implications
Is there any producer surplus in the long run?
Is there any economic profit in the long run?
Is there allocative efficiency in the long run?
REVIEW:
What is Allocative Efficiency in a Perfectly Competitive Market?
Perfect Competition
Monopolistic Competition
The value of
diversity!
Avinash Dixit
Joseph Stiglitz
Standardized Product, Low Barriers → Perfect Competition
P=min AVC
No producer surplus or profit in the long-run
Diversified Product, Low Barriers → Monopolistic Competition
P > min AVC price of diversity!
No producer surplus or profit in the long-run
Standardized Product, High Barriers → Monopoly, Oligopoly
Depends on the model!
Cornout: P> min AVC, long-run profit
Bertrand: P=min AVC, no profit
Diversified Product, High Barriers → Monopoly, Oligopoly
P > min AVC
Long run profit