Models of Competition Part IIIb: Other Oligopoly Models & Monopolistic Competition Agenda: Cornot gnome problem answers Other Oligopoly Models A. Stackelberg – first mover advantage B. Bertrand – choose price 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! 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? 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 Heinrich Freiherr von Stackelberg 1905 - 1946 Substitute firm #2’s response function assuming MC = 0 What is Firm #1’s Marginal Revenue Function? Firm #1 Demand Function

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!!

Joseph Louis François Bertrand Oligopoly: The Bertrand Model Firms choose price and the market sets quantity Each firm takes the other’s price as given Firm #1 Lower Price Same Price Higher Price Joseph Louis François Bertrand  (1822 – 1900) Firm #2 Lower Price all half nothing all all all all half nothing Same Price Price set at MC Same as perfect competition! half half half Higher Price all half nothing nothing nothing nothing 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 Chamberlin, E.H. (1933) The Theory of Monopolistic Competition: A Re-orientation of the Theory of Value. Harvard University Press, Cambridge MA. Robinson, J. (1933) The Economics of Imperfect Competition, MacMillian, London. Poor Joan was British and a woman and the paper was written in 1933, so as Americans we only refer to the “Chamberlin” model Friedman argued that Chamberlin model added nothing to the model of perfect competition (1953) “The methodology of positive economics,” in Essays in Positive Economics, Chicago: Chicago University Press. Dixit and Stiglitz (1977) “Monopolisitc competition and optimum product diversity” American Economic Review, 67:297 – 308 Symmetry is necessary to make the math models work, not for the intuition, so we won’t focus on that. 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 Joan Robinson Market demand curve Which is more ELASTIC? Firm demand curve P2 Firm demand is more elastic because customers can easily switch to competitors – but if you need (want) a shirt you ultimately get one so market demand is less elastic 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 REVIEW: What is Allocative Efficiency? 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?

What is Allocative Efficiency in a Perfectly Competitive Market? REVIEW: What is Allocative Efficiency in a Perfectly Competitive Market? What can make the supply curve slope up in the long-run? Is there producer surplus in the long run? Is there consumer surplus in the long run? See P&R p. 455 for a graphical comparison of long-run equilibrium in perfect and monopolistic competition

Monopolistic Competition 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