2. Two Models of Oligopolistic Competition: Bertrand and Cournot

3. Models of Competition Monopoly Bertrand’s model Cournot’s model
Quantity can be easily adjusted.
Cournot’s model
Quantities are chosen first, and can’t be easily altered; then prices are set.
Today we’re going to talk about two ideas about, or models of, of competition. Both were developed in the 19C, interestingly both by French economists.
The first model is one in which the quantity of goods sold can be easily changed – for example when you are a retailer buying product on a on a week by week basis. The second is for the case in which it is hard to alter the amount you make, for example if you have to build a factory and have to run it at capacity to make money.
Both made predictions about the effect of competition compared to the prices and profits attainable in a monopoly. We are assuming her that we are talking about a commodity product, that is to say one that is completely un-differentiated.

4. =4 Demand: p=5-q Monopolist Market price P* = 3 c=1 Quantity q* = 2
But before we look at Bertrand’s and Cournot’s models, we need to consider that case of a monopoly.
=4
c=1
Quantity
q* = 2

5. Bertrand’s Model of Competition
Price
LRAC
Bertrand’s idea was quite straightforward. He argued that while a monopolist could determine price grater than its long run average costs, as soon as a second firm entered the market successive rounds of price cutting would lead to prices falling to exactly long run average costs. In other words, with two firms or more in a market, no profit can be made by any of them. The only way to make money according to Bertrand is to be a monopolist.
There is a problem with this model in that we see lots of cases in which small number (but numbers larger than 1) of firms do make quite substantial amounts of money. 1 2 3 4 5 6
# of firms
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B189 - Simon Rodan 5

6. The Oil Super Majors Sales ($B) Net Income ($B) ROS Royal Dutch Shell
475 26 5%
Exxon
434 45
10% BP
377 17
Chevron
230 27
12%
Total SA
222 14 6%
The oil industry is an example. Oil is a commodity product and there are several firms (Exxon, BP, Chevron, Shell, and Total are the so called ‘super majors’) in the industry.
As this slide shows, all five ‘super majors’ are making sizable returnes (even Total, the smallest is making 11 billion dollars). And none is making less than 5% return on sales.
Data are for FY2011

7. Expected Duopoly Profit
Market
price
Demand:
p=5-q
P* = 3
So, going back for a second to the monopoly model, one might expect that with two firms, they would simply divide up the market between them, each making half the profit.
2=2
2=2
c=1
Quantity
q* = 2

8. Cournot’s Duopoly Prediction
Market
price
1 and 2=3.54
P* = 2.33
Demand:
p=5-q
=1.77
=1.77
c=1
Quantity
Simulation
q* = 2.66

9. Cournot’s Duopoly Prediction
Market
price
1,2 and 3=3
Demand:
p=5-q
P* = 2
=1
=1
=1
c=1
Quantity
q* = 3

10. Cournot’s Model of Competition
# of firms
Potential price 1 2 3 4 5 6
LRAC
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B189 - Simon Rodan 10

11. Firm Size Industry Profile

12. Industry concentration
Industries with few firms are ‘concentrated’
Industries with many firms are ‘fragmented’
However, most industries have both large and small firms

13. Some Examples

14. Assessing concentration
Four Firm Concentration Ratio (CR4)
Add up the sales for all firms in the industry
Add up the sales of the four largest firms in the industry
Divide the second number by the first OR
Add the market shares of the four largest firms (this is exactly equivalent to the first method)