1. 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!

2. 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 = P or P = 65 – Q/100
FIRM total cost: C(q) = 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

3. 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
Substitute firm #2’s response function assuming MC = 0
What is Firm #1’s
Marginal Revenue Function?
Firm #1
Demand Function

4. 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!!

5. 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

6. 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

7. 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?

8. 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?

9. 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

10. Monopolistic Competition
Perfect Competition
Monopolistic Competition
The value of
diversity!
Avinash Dixit
Joseph Stiglitz

11. 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