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Chapter 9 Basic Oligopoly Models

This chapter discusses basic oligopoly models including Sweezy, Cournot, Stackelberg, and Bertrand models. It explains the characteristics and assumptions of each model regarding firm behavior, pricing, and profits. The learning objectives are to understand how strategic interaction affects decisions in oligopolies and to identify the conditions that define each oligopoly model along with their implications. Key aspects of the models like reaction functions, demand curves, and profit maximization are also covered.

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Angela Wagan
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274 views8 pages

Chapter 9 Basic Oligopoly Models

This chapter discusses basic oligopoly models including Sweezy, Cournot, Stackelberg, and Bertrand models. It explains the characteristics and assumptions of each model regarding firm behavior, pricing, and profits. The learning objectives are to understand how strategic interaction affects decisions in oligopolies and to identify the conditions that define each oligopoly model along with their implications. Key aspects of the models like reaction functions, demand curves, and profit maximization are also covered.

Uploaded by

Angela Wagan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Basic Oligopoly Models

Chapter 9
Learning Objectives:
After completing this chapter, you will be able to:
LO1 Explain how beliefs and strategic interaction shape optimal
decisions in oligopoly environments.
LO2 Identify the conditions under which a firm operates in a
Sweezy, Cournot, Stackelberg, or Bertrand oligopoly, and
the ramifications of each type of oligopoly for optimal pricing
decisions, output decisions, and firm profits.
LO3 Apply reaction (or best-response) functions to identify
optimal decisions and likely competitor responses in oligopoly
settings.
LO4 Identify the conditions for a contestable market, and explain
the ramifications for market power and the sustainability of
long-run profits.
Oligopoly A market structure in which there are only a few
firms, each of which is large relative to the total
industry.

THE ROLE OF BELIEFS AND STRATEGIC INTERACTION


Demand is more inelastic when
rivals match a price change than
when they do not. For a given price
reduction, a firm will sell more if
rivals do not cut their prices (D2)
than it will if they lower their prices
(D1). In effect, a price reduction
increases quantity demanded
only slightly when rivals respond by
lowering their prices. Similarly, for a
given price increase, a firm will sell
more when rivals also raise their
prices (D1) than it will when they
maintain their existing prices (D2).
PROFIT MAXIMIZATION IN FOUR OLIGOPOLY SETTINGS

Sweezy oligopoly An industry in which (1) there are few firms serving many
consumers; (2) firms produce differentiated products; (3)
each firm believes rivals will respond to a price reduction
but will not follow a price increase; and (4) barriers to
entry exist.
The manager of a firm competing in
a Sweezy oligopoly believes other
firms will match any price decrease
but not match price increases, the
demand curve for the firm’s product
is given by ABD1.

The profit-maximizing level of output


occurs where marginal revenue
equals marginal cost, and the profit-
maximizing price is the maximum
price consumers will pay for that
level of output.
Cournot An industry in which (1) there are few
oligopoly
firms serving many consumers; (2) firms
produce either differentiated or
homogeneous products; (3) each firm
believes rivals will hold their output
constant if it changes its output; and (4)
barriers to entry exist.
Stackelberg An industry in which (1) there are few firms serving
oligopoly many consumers; (2) firms produce either
differentiated or homogeneous products; (3) a
single firm (the leader) chooses an output before
rivals select their outputs; (4) all other firms (the
followers) take the leader’s output as given and
select outputs that maximize profits given the
leader’s output; and (5) barriers to entry exist.
Bertrand An industry in which (1) there are few firms serving
oligopoly many consumers; (2) firms produce identical
products at a constant marginal cost; (3) firms
compete in price and react optimally to
competitors’ prices; (4) consumers have perfect
information and there are no transaction costs; and
(5) barriers to entry exist.
Contestable A market in which (1) all firms have
Market
access to the same technology; (2)
consumers respond quickly to price
changes; (3) existing firms cannot
respond quickly to entry by lowering
their prices; and (4) there are no sunk
costs.
In this chapter, we examined several models of markets that
consist of a small number of strategically interdependent firms.
These models help explain several possible types of behavior when
a market is characterized by oligopoly. You should now
be familiar with the Sweezy, Cournot, Stackelberg, and Bertrand
models. In the Cournot model, a firm chooses quantity based on
its competitors’ given levels of output. Each firm earns some
economic profits. Bertrand competitors, on the other hand, set
prices given their rivals’ prices. They end up charging a price equal
to their marginal cost and earn zero economic profits. Sweezy
oligopolists believe their competitors will follow price decreases
but will ignore price increases, leading to extremely stable prices
even when costs change in the industry. Finally, Stackelberg
oligopolies have a follower and a leader. The leader knows how
the follower will behave, and the follower simply maximizes profits
given what the leader has chosen. This leads to profits for each
firm but much higher profits for the leader than for the follower.

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