Models of Competition Part IIIa: Cournot Oligopoly Agenda: A continuum of competition: two key questions Models of Imperfect Competition – Overview Cournot – Choose quantity A. Marginal revenue function B. Response function C. Equilibrium condition D. Competing garden gnomes

Monopolistic Competition A Continuum of Competition…. Perfect Competition Monopolistic Competition Oligopoly Monopoly Causes of monopoly: Economies of scale (production technology – go back to gnomes), regulation (we don’t want everyone tearing up the roads to lay gas pipe, we want to know who to go to when something blows up) Network externalities, Location (also a form of product differentiation) Patents Of the four assumptions underlying perfect competition, really only two are important: product differentiation and barriers to entry/exit. Pricing power comes from these (assumption #2) and we never have perfect information (transactions costs) Key questions: Is there meaningful product differentiation? Are there significant barriers to entry or exit?

Models of imperfect competition Model Assumptions Limitations Monopolistic Competition Differentiated Products are imperfect substitutes NO barriers to entry Firms act independently, do NOT respond to other firms Oligopoly Products are close substitutes HIGH barriers to entry (including economies of scale) Cournot Firms take other firms’ QUANTITY as given Firms produce equal quantities Stackelberg 2nd mover can NOT respond to 1st mover 1st mover advantage. 1st mover produces same quantity as monopolist. Bertrand Firms simultaneously choose PRICE Price = MC same as perfect competition Game Theory! Firms strategically anticipate and respond to other firms’ actions Few Nash equilibria, context specific implications

Antoine Augustin Cournot Oligopoly: The Cournot Model Few firms (test yourself: why?) Firms choose quantity at the same time and then the market sets price Products must be relatively close substitutes. 5 75 Antoine Augustin Cournot (1801-1877) KEY: Each firm takes the other’s quantity as GIVEN, which reduces the demand available to them! See P&R p. 459

Antoine Augustin Cournot Oligopoly: The Cournot Model A firm’s RESPONSE FUNCTION expresses its Quantity in terms of the other firm’s Quantity Antoine Augustin Cournot (1801-1877) Recall the general linear demand function: Response functions with MC = 0 Equilibrium is when Q1 = Q2 See P&R p. 461 for a numerical derivation which requires some calculus to get the marginal revenue.

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? 2. What is the response function for Q1 (an expression for Q1 in terms of Q2)? HINT: remember, if in doubt try MR = MC! What happens if you don’t have symmetry? In other words, what if both firms have different marginal cost functions? No problem! You just substitute the specific response function for Q2 in terms of Q1 to get to one equation and one unknown. The math is messy, but you can do it! 3. How much does Q1 produce? HINT: remember there is symmetry in the response functions since both firms have the same cost structure. 4. What is the equilibrium price and quantity for the market?

TEST YOURSELF! Compare the equilibrium price, quantity, profit, producer and consumer surplus for the perfectly competitive, monopoly and Cournot Duopoly markets! 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 Model Price Quantity Perfect Competition $5 6,000 Monopoly $43.33 2,167 Cournot Oligopoly $32.48 3,252