1. Oligopoly Managerial Economics Kyle Anderson
Kelley School of Business – Indiana University

2. What makes oligopoly different?
Profit max is still MR=MC.
Competitors (optimally) respond to a firm’s actions.
This response will affect demand and MR.
Anticipate rivals’ actions in making decisions. $
Lower price? MC D D*
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MR* MR

3. Cournot oligopoly Few firms serving many customers.
Firms produce either differentiated or identical products.
Firms compete on the basis of output, the market determines price.
Barriers to entry exist.
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4. Cournot oligopoly Firms choose output first.
The supply curve is the sum of all firms’ output.
Then, based on supply and the level of demand, price is determined.
Firms want to choose the profit maximizing output.
Cournot oligopoly
SLow
SHigh $ P* P D
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5. Cournot oligopoly Market demand in a Cournot duopoly is:
Thus, each firm’s marginal revenue depends on the output produced by the other firm. More formally,
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6. Cournot marginal revenue
P = a – bQ  Market Demand, Q=q1+q2 P = a – b(q1+q2) TR1 = q1*P = q1*(a - bq1 - bq2) TR1 = aq1 – bq12 – bq1q2 MR1 = a – 2bq1 – bq2
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7. Solving for Cournot (Example)
Suppose there are two furniture mfrs. in a country (and no imports). Market (inverse) demand for couches is P = 2000 – .5Q. Both firms produce at a cost C(Q) = 300, Q. What are industry output, firm output, price, and profits?
Firm 2 produces 0?
Firm 2 produces 3000?
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8. Cournot reaction functionQ1
1500
Firm 1’s Reaction Function Q2
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3000

9. Solving for Cournot
Now we examine firm 2:
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10. Cournot reaction functionQ1
Firm 2’s Reaction Function
3000
1500
Firm 1’s Reaction Function Q2
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1500
3000

11. Cournot equilibrium
Q1 = 1000, Q2 = 1000, Q=2000 P= Q, P = $1000 Firm π = 1000(1000) – ( (1000)) = $200,000
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12. Cournot vs. Monopoly Cournot Monopoly
Total output 2,000 Price $1000 Profits $200,000
Total output 1,500 Price $1250 Profits $825,000
Collusion
Collusion
Total output 1,500 – firm 750
Price $1250
Profits $262,500
Collusion is illegal in U.S.
Q1 = 1500 – ½ Q2
Cheating is hard to detect.
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13. Cournot Model Variations
More than two firms:
One firm moves first:
Stackelberg model
Assumes one firm can commit first.
The first firm chooses a larger output and earns higher profits.
Second firm smaller output.
Overall output is higher than Cournot.
First mover advantage
Each firm’s output is smaller.
Overall output is higher.
Price is lower.
From the consumer point of view – the more firms the better.
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14. Bertrand Oligopoly Few firms serving many customers
Firms compete on the basis of price
Barriers to entry exist
Identical products, constant MC
Perfect information, no transaction costs
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15. Undercutting continues until:
Bertrand Competition
Two firms, 10 customers, each wanting 1000 brake pads. Both firms can produce a large supply at a constant MC = $20. What price should a firm charge?
$30
$28
$26
$25
Undercutting continues until:
P = Marginal Cost
$24
$21
Bertrand Trap
$20.10
$20.09
$20
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16. Managing out of the Bertrand Trap?
Mr. Crandall: I think it’s dumb as hell for Christ’s sake, all right, to sit here and pound the out of each other and neither one of us making a dime.
Mr. Putnam: Do you have a suggestion for me?
Mr. Crandall: Yes, I have a suggestion for you. Raise your goddamn fares 20 percent. I’ll raise mine the next morning.
Mr. Putnam: Robert, we...
Mr. Crandall: You’ll make more money and I will, too.
Mr. Putnam: We can’t talk about pricing!
Mr. Crandall: Oh , Howard. We can talk about any goddamn thing we want to talk about.
Robert Crandall – Pres. American Airlines
Howard Putnam – CEO Braniff
February 21, 1982
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17. Managing out of the Bertrand Trap
Few firms serving many customers
Firms compete on the basis of price
Barriers to entry exist
Identical products, constant MC
Perfect information, no transaction costs
Product differentiation
Collusion – explicit vs. tacit
Uninformed consumers
Transaction costs
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18. Product Differentiation
Bruce Hall: Beer Vendor Pittsburgh Steelers and Pirates Age: 41 Pay: $175 to $300 per Steelers game; $50 to $150 at Pirates games. He works on commission.
“The Miller Lite guys might sell a little more than me, but I can usually hang with them. Bud Light does pretty well for football. Twenty-some years ago, nobody cared about the brand. It was always just ‘Beer here. Beer here.’ Now people want their Miller Lite, their Bud Light, their Yuengling.”
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19. Loyal Customers MC=$20, Max price=$30 What price do you charge?
Loyal to You
Shoppers
Loyal to me
MC=$20, Max price=$30
What price do you charge?
Note that you can always earn $10, by charging $30.
Always price between $21.11 and $ ($10/9=$1.11)
Price above marginal cost!
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20. The higher the proportion of loyal customers, the higher the prices!
Loyal to You
Shoppers
Loyal to me
MC=$20, Max price=$30
What price do you charge?
Now you can always earn $40, by charging $30.
Always price between $26.67 and $ ($40/6 = $6.67)
The higher the proportion of loyal customers, the higher the prices!
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21. Uninformed consumers Consumers lack perfect information on prices.
Information is costly, so not getting information can be rational.
As a result, firms that charge higher prices still make sales.
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Source: Indianagasprices.com

22. Price Matching Guarantees
Price matching is not always a good thing for consumers.
Little incentive for firms to lower price.
May lead to tacit collusion.
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23. Transactions costs: Example: distance between competitors.
Switching costs are a form of transaction cost that allows firms to charge prices above MC.
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24. Bertrand Lessons Pure Bertrand rarely, if ever exists.
Evaluating markets:
Identical products
Constant marginal cost
Perfect information
No transaction costs
Pricing close to MC
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25. Oligopoly Different models make different predictions.
Firms make decisions based on the anticipation of what their rivals’ will do.
Game theory – strategic interaction between players.
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