Slide 1Copyright © 2004 McGraw-Hill Ryerson Limited Chapter 13 Oligopoly and Monopolistic Competition

Slide 2Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-1 The Profit-Maximizing Cournot Duopolist The Cournot duopolists demand curve is obtained by shifting the vertical axis rightward by the amount produced by the other duopolist (Q 2 in the diagram). The portion of the original market demand curve that lies to the right of this new vertical axis is the demand curve facing firm 1. Firm 1 then maximizes profit by equating marginal revenue and marginal cost, the latter of which is zero.

Slide 3Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-2 Reaction Functions for the Cournot Duopolists The reaction function for each duopolist gives its profit-maximizing output level as a function of the other firms output level. The duopolists are in a stable equilibrium at the point of intersection of their reaction functions.

Slide 4Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-3 Deriving the Reaction Functions for Specific Duopolists Panel a shows the profit-maximizing output level for firm 1 (Q ) when firm 2 produces Q 2. That and the parallel expression for firm 2 constitute the reaction functions plotted in panel b. *1*1

Slide 5Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-4 The Stackelberg Leaders Demand, Marginal Revenue, and Profit Functions (a) When firm 1 knows firm 2 is a Cournot duopolist, it can take account of the effect of its own behaviour on firm 2s quantity choice. The result is that it knows exactly what its (residual) demand curve will be. (b) Firm 1s profit function, with zero costs, is 1 = PQ 1 = (aQ 1 – bQ 1 2 )/2, which reaches a maximum at Q = a/(2b), with = a 2 /8b. *1*1 *1*1

Slide 6Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-5 The Stackelberg Equilibrium In the Stackelberg model, firm 1 ignores its own reaction function from the Cournot model. It chooses its own quantity to maximize profit, taking into account the effect that its own quantity will have on the quantity offered by firm 2.

Slide 7Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-6 Comparing Equilibrium Price and Quantity The monopolist would maximize profit where marginal revenue equals zero, since there are no marginal production costs. The equilibrium price will be higher, and the equilibrium quantity lower, than in the Cournot, Stackelberg, and Bertrand cases.

Slide 8Copyright © 2004 McGraw-Hill Ryerson Limited TABLE 13-1 Comparison of Oligopoly Models All five models assume a market demand curve of P = a –bQ and two identical firms with marginal cost equal to zero. (Of course, if marginal cost is not zero, some entries will differ from the ones shown.)

Slide 9Copyright © 2004 McGraw-Hill Ryerson Limited TABLE 13-2 Why Minimax? In game (a), each player has a dominant strategy: the equilibrium is in the northeast cell of the matrix. In games (b), (c), and (d), Ron has no dominant strategy. In game (b), Colleens dominant strategy (c 1 ) minimizes her losses regardless of Rons strategy. In games (c) and (d), Colleen has no dominant strategy, but her minimax strategy (c 1 ) minimizes the maximum loss she could sustain.

Slide 10Copyright © 2004 McGraw-Hill Ryerson Limited TABLE 13-3 The Prisoners Dilemma Each player believes he will always get a shorter sentence by confessing, no matter what the other player does. And if each player confesses, each gets 5 years. Yet if both players had remained silent, each would have gotten only 1 year in jail. Here, the individual pursuit of self-interest produces a worse outcome for each player.

Slide 11Copyright © 2004 McGraw-Hill Ryerson Limited TABLE 13-4 Profits to Cooperation and Defection The dominant strategy is for each firm to defect, for by so doing it earns higher profit no matter which option its rival chooses. Yet when both defect, each earns less than when each cooperates.

Slide 12Copyright © 2004 McGraw-Hill Ryerson Limited TABLE 13-5 The Advertising Decision as a Prisoners Dilemma In many industries the primary effect of advertising is to cause consumers to switch brands. In such industries, the dominant strategy is to advertise heavily (lower right cell), even though firms taken as a whole would do better by not advertising (upper left cell).

Slide 13Copyright © 2004 McGraw-Hill Ryerson Limited TABLE 13-6 A Game in Which Firm 2 Has No Dominant Strategy Firm 1 earns higher profits by advertising, no matter what firm 2 does. Its dominant strategy is to advertise. But firm 2 has no dominant strategy. If firm 1 advertises, firm 2 does best also to advertise, but if firm 1 does not advertise, firm 2 does best not to advertise.

Slide 14Copyright © 2004 McGraw-Hill Ryerson Limited EXERCISE 13-4

Slide 15Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-7 Theme Park Decision If Joyworld enters, then Funland must decide whether to build the Devil Twist. Since Funland earns a higher profit at E than at D, it will not build the Devil Twist. Hence Joyworld will enter the market.

Slide 16Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-8 Strategic Entry Deterrence Had it originally purchased the additional land, Funland could earn more profits by building the Devil Twist than by not building it, if Joyworld entered. Hence Joyworld doesnt enter. The Nash equilibrium of the altered game is now at point C.

Slide 17Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE 13-9 Time-Path of Output and Prices with Zero Entry Costs With MC = 0, no entry costs, and one potential entrant per period, over time the equilibrium Q approaches the competitive output level and P approaches zero.

Slide 18Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE An Industry in Which Location Is the Important Differentiating Feature Restaurants (heavy black squares) are the same except for their geographic location. Each person dines at the restaurant closest to home. If the circumference of the loop is km, this means that the distance between restaurants will be km, giving rise to a maximum one-way trip length of km

Slide 19Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE Distances with N Outlets With N outlets, the distance between adjacent outlets will be 1/N. The farthest a person can live from an outlet is 1/2N. And the average one-way distance people must travel to reach the nearest outlet is 1/4N. The average round-trip distance is 1/2N.

Slide 20Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE The Optimal Number of Outlets Total transportation cost (C trans ) declines with the number of outlets (N), while total cost of meals served (C meals ) increases with N. The optimal number of outlets (N*) is the one that minimizes the sum of these costs.

Slide 21Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE A Spatial Interpretation of Airline Scheduling In a market with four flights per day, there is no traveller for whom there is not a flight leaving within 3 hours of his most preferred departure time.

Slide 22Copyright © 2004 McGraw-Hill Ryerson Limited FIGURE The Hot Dog Vendor Location Problem Each hot dog vendor does best by positioning himself at the centre of the beach, even though that location does not minimize the average distance that their customers must travel.

Slide 23Copyright © 2004 McGraw-Hill Ryerson Limited Figure A Political Location Problem Initially the two parties in a single-issue election are at A and B. Competition for votes compels them to re- position their platforms closer to the midpoint 0, at A and B.

Slide 24Copyright © 2004 McGraw-Hill Ryerson Limited PROBLEM 1

Slide 25Copyright © 2004 McGraw-Hill Ryerson Limited PROBLEM 8

Slide 26Copyright © 2004 McGraw-Hill Ryerson Limited ANSWER 13-1