bài giảng kinh tế vi mô tiếng anh ch13 imperfect competition

1
Chapter 13
Oligopoly and Monopolistic
Competition
Key issues
1. market structure
2. game theory
3. cartels
4. Cournot model of oligopoly
5. Stackelberg model of oligopoly
6. monopolistic competition
7. Bertrand model of oligopoly
Market structures
markets differ according to
• number of firms in market
• ease of entry and exit
• ability of firms to differentiate their
products
Oligopoly
• small group of firms in a market with substantial
barriers to entry
• because relatively few firms compete in such a
market,
• each firm faces a downward-sloping demand curve
• each firm can set its price: p > MC
• market failure: inefficient (too little) consumption
• each affects rival firms
• typical oligopolists differentiate their products
Monopolistic competition
• small or moderate number of firms
• free entry

• π = 0
• p = AC
• usually products differentiated
2
Strategies and games
• oligopolistic or monopolistically competitive firm
use a
• strategy:
• battle plan of actions (such as setting a price or
quantity) it will take to compete with other firms
• oligopolies engage in a
• game:
• any competition between players (such as firms) in
which strategic behavior plays a major role
Game theory
• set of tools used by economists, political
scientists, military analysts, and others to analyze
decision making by players (such as firms) who
use strategies
• these analytic tools can be used to analyze
• oligopolistic games
• poker
• coin-matching games
• tic-tac-toe
• elections
• nuclear war
Firm's objective
• obtain largest possible profit (or payoff) at
game’s end
• typically, one firm's gain comes at expense

of other firms
• each firm's profit depends on actions taken
by all firms
Nash equilibrium
• set of strategies is a Nash equilibrium if,
• holding strategies of all other players (firms) constant,
• no player (firm) can obtain a higher payoff (profit) by
choosing a different strategy
• in a Nash equilibrium, no firm wants to change its
strategy because each firm is using its
• best response:
• strategy that maximizes its profit given its beliefs about
its rivals' strategies
Duopoly
• consider single-period, duopoly, quantity-
setting game
• duopoly: an oligopoly with two ("duo")
firms
Airlines Example
• American Airlines and United Airlines
• compete for customers on flights between
Chicago and Los Angeles
3
Notation
• Q = total number of passengers flown by
both firms; sum of:
• q
A
= passengers on American Airlines
• q

U
= passengers on United Airlines
Firms act simultaneously
• each firm selects a strategy that
• maximizes its profit
• given what it believes other firm will do
• firms are playing
• a noncooperative game of imperfect
information:
• each firm must choose an action before
observing rivals’ simultaneous actions
Dominant strategy
• a strategy that strictly dominates all other
strategies regardless of which actions rivals’
chose
• in this Table 13.2 game, each firm has a
dominant strategy
• firm chooses its dominant strategy
• where a firm has a dominant strategy, its
belief about its rival's behavior is irrelevant
Noncooperative game
• firms do not cooperate in a single-period
game
• In Nash equilibrium (q
A
= q
U
= 64), each
firm earns $4.1 million (< $4.6 million it
would make if firms restricted their outputs

to q
A
= q
U
= 48)
• sum of firms' profits is not maximized in
this simultaneous choice, one-period game
Why don't firms cooperate?
• don't cooperate due to a lack of trust:
• each firm can profitably use low-output
strategy only if it trusts other firm!
• each firm has a substantial profit incentive
to cheat on a collusive agreement
4
Prisoners' dilemma game
all players have dominant strategies that
lead to a profit (or other payoff) that is
inferior to what they could achieve if they
cooperated and played alternative strategies
Collusion in repeated games
• in a single-period prisoners' dilemma game,
firms produce more than they would if they
colluded
• why, then, are cartels frequently observed?
• collusion is more likely in a multiperiod
game: single-period game played repeatedly
• punishment: not possible in a single-period
game but possible in a multiperiod game
Supergame
• if a single-period game is played repeatedly, firms

engage in a
• supergame:
• players’ strategies in this period may depend on rivals'
actions in previous periods
• in a repeated game, firm can influence its rival's
behavior by
• signaling
• threatening to punish
Threat
• suppose American announces to United that
it will use the following two-part strategy:
• American produces smaller quantity each
period as long as United does the same
• if United produces larger quantity in period t,
then American will produce larger quantity in
period t + 1and all subsequent periods
• thus, if firms play same game indefinitely,
they should find it easier to collude
Know number of periods
• suppose firms know that they are going to play
game for T periods
• period T is like a single-period game, and all firms
cheat
• hence T-1 period is last interesting period
• by same reasoning, they cheat in that period, etc.
• cheating is less likely to occur if end period is
unknown or there is no end
Cartels
Adam Smith:
"People of the same trade seldom meet

together, even for merriment and diversion,
but the conversation ends in a conspiracy
against the public, or some contrivance to
raise prices"
5
Why cartels form
• cartel can raise profits by raising price
• limit entry
• demand elasticity not too large
• low expectation of severe punishment
• low organization costs
• few firms
• national association
Why can cartels raise profits?
• if a competitive firm is maximizing its
profit, why should joining a cartel increase
its profit?
• competitive firm is already choosing output to
maximize its profit
• however, it ignores effect that changing its
output level has on other firms' profits
• cartel takes into account how changes in
one firm's output affect cartel profits
Historic cartels
in late nineteenth century, cartels (trusts)
were legal and common in the United States
• oil
• railroads
• sugar
• tobacco

• steel
Laws against cartels
• in response to trusts' high prices, Congress passed
• Sherman Antitrust Act in 1890
• Federal Trade Commission Act of 1914
• these laws prohibit firms from explicitly agreeing
to take actions that reduce competition, such as
jointly setting price
• these anti-cartel laws are called
• antitrust laws in U.S.
• competition policies in most other countries
Effectiveness of Antitrust Laws
• at first they had no bite because the
language was vague and full of loopholes
• mocked as “the Swiss Cheese Act”
Supreme Court
• In 1902, Teddy Roosevelt had DOJ sue
Northern Securities Company (railroad—
part of J.P. Morgan empire) under the
Sherman Act
• 1906 sued to dissolve Rockefeller’s
Standard Oil
• 1911: Supreme Court breaks up oil trust—
Sherman Act gains teeth
6
Europe
• over the last dozen years, the European Commission has
been pursuing competition cases under laws that are
similar to U.S. antitrust laws
• recently the EC, the DOJ, and the FTC have become

increasingly aggressive, prosecuting many more cases
• following the U.S., which uses both civil and criminal
penalties, the British government introduced legislation in
2002 to criminalize certain cartel-related conduct
• EU uses only civil penalties, but its fines have increased
dramatically, as have U.S. fines
Corporate Leniency Program
• in 1993, DOJ introduced a new Corporate
Leniency Program that guarantees that participants
in cartels who blow the whistle will receive
immunity from federal prosecution
• as a consequence, DOJ has caught, prosecuted,
and fined several gigantic cartels (e.g. Vitamins)
• on Valentine’s Day, 2002, EC adopted a similar
policy
Sotheby’s and Christie’s
• Sotheby’s (established in 1744) and Christie’s
(1776) are the two largest and most prestigious
auction houses in the world
• they control 90% of the $4 billion worldwide
auction market
• for most of the last two and a half centuries, they
thrived
• starting at least by 1993, when faced with poor
business conditions, they started to collude,
according to the U.S. Department of Justice (DOJ)
Auctions (cont.)
• DOJ started investigating in 1997, but
gained the necessary evidence in 2000,
when Christie’s approached both DOJ and

European Commission with proof that it
had conspired with Sotheby’s to fix prices
• Christie’s applied for leniency under the
U.S. antitrust laws, effectively “shopping”
its rival
Auctions (cont.)
• DOJ charged that the pair
• held meetings between top-level executives
• exchanged confidential lists of super-rich clients
• agreed to limit which customers received lower
commissions
• charged identical commission rates (a sliding scale up
to 20%) to other sellers who had little negotiation
power
• Sotheby’s paid a $45 million fine
• the two auction houses agreed to pay more than
$512 million to former clients to settle lawsuits
Auctions (cont.)
• A. Alfred Taubman, Sotheby’s former chairman
and who still held a 21% share of stock and
controlled 63% of its voting rights, was sentenced
for price fixing to a year in prison and fined $7.5
million in 2002
• Christie’s former chairman, Sir Anthony Tennant,
lives in England has refused to come to the United
States to face trial
• however, days before Taubman’s conviction, the
European Commission brought charges against
both auction houses
7

Why some cartels persist
1. tacit collusion
2. international cartels (OPEC) and cartels
within certain countries operate legally
3. illegal cartel believes it can avoid detection
or punishment will be small
Cartels fail
luckily for consumers, cartels often fail
because
• each firm in a cartel has an incentive to
cheat on the cartel agreement by producing
extra output
• governments forbid them
Why cartels fail
• cartels fail if noncartel members can supply
consumers with large quantities of goods
(example: copper)
• each member of a cartel has an incentive to
cheat on cartel agreement
Figure 13.1 Competition Versus Cartel
Price, p,
$ per unit
(a) Firm
q
c
q*q
m
Quantity, q, Units
per year
S

MR
Market demand
AC
MC
p
m
MC
m
p
c
p
m
e
m
e
c
MC
m
p
c
Price, p,
$ per unit
(b) Market
Q
m
Q
c
Quantity, Q, Units
per year
Solved problem

• initially, all identical firms in a market
collude
• if some of these firms leave the cartel and
act like price takers, how are consumers
affected?
8
Maintaining cartels
to maintain a cartel, firms must
• detect cheating
• punish violators
• keep its illegal behavior hidden from
governments
Detection and enforcement
• inspect each other's books (e.g., most-favored
nation clauses)
• governments report bids on
government contracts
• divide market by region or by customers
mercury cartel (1928-1972) allocated
U.S. to Spain and Europe to Italy
• use industry organizations to
detect cheating
• offer "low price" guarantees
Government created cartels
• U.S., European, & other governments established
a cartel in 1944 that fixed prices for international
airline flights and prevented competition
• baseball teams exempted from some U.S. antitrust
laws since 1922
Bud Selig, baseball's commissioner: “[The baseball]

antitrust exemption is protection for the fans.”
Automobile cartel
• Reagan admin. negotiated 1981 voluntary export
restraints (VER): Japanese auto manufacturers
would reduce their auto exports to U.S.
• Why would Japanese manufacturers “voluntarily”
reduce their exports?
• to avoid government quotas
• to act like a cartel: reducing sales to collusive level
• when U.S. allowed VER agreements to lapse in
1985, Japanese government wanted to continue to
restrict exports
Auto cartel effects
• stock market value of Japanese auto industry
increased during VER period by $6.6 billion
• VERs raised price of American cars by 5.4%
between 1981 and 1983
• U.S. consumers lost $6.9 billion ($1984) due to
these export restrictions
• using VER is foolish
• foreign and domestic auto manufacturers capture
“cartel” profits from higher prices
• tariffs better for U.S.
Entry and cartel success
• barriers to entry help cartel: limit competition
• cartels with large number of firms rare (except
professional associations)
• Dept. of Justice price-fixing cases 1963-1972
• 48% involved 6 or fewer firms
• average number of firms: 7.25

• only 6.5% involved 50 or more conspirators
• cartels often fall apart after entry (mercury)
9
Bail bonds
• Connecticut sets a maximum fee bail-bond
businesses can charge for posting a given-
size bond
• how close a city’s price is to legal
maximum depends on number
of firms
648New Haven
543Norwalk
7810Bridgeport
982Meriden, New London
991Plainville, Stamford,
Wallingford
% of maximum
allowed fee
# of active
firms
Town
Lysine cartel
• 1996: Archer Daniels Midland (ADM)
pleaded guilty to price fixing
• ADM admitted to price fixing in lysine
(used in livestock feed) and citric acid (used
in soft drinks and detergents)
• source of following: Connor (1993)
Lysine market
• share of global production of 4 largest

manufacturers of lysine in early 1990s
• > 97% in U.S.
• > 95% world
• CR4 of buyers < 30%
• large infrequent purchases
• cost of a new plant $150+ million (over 3 years to
build)
• perfectly homogeneous product
Lysine fines
• 5 corporate fines
• U.S. corporate fines: $92.5 million
• EU: $97.9 million
• Canada: $11.5 million
• lysine cartel U.S. fine was 7x previous highest
fine
• 7 personal fines
• in 1999, 3 people got prison sentences of 99
months total (indiv. max 36 months)
Individual fines
Michael D. Andreas (U.S.), Vice Chairman, ADM, $350,000
fine, 36 months of jail
Terrance Wilson (U.S.), Pres., Corn Products Div., ADM,
$350,000, 33 months
Mark Whitacre (U.S.), Pres., Bioproducts Div., ADM,
$350,000, 30 months
Kanji Mimoto (J), Div. Mgr., Ajinomoto, $75,000
Hirozaku Ikeda (J), Div. Mgr., Ajinomoto $0
Kaztoshi Yamada (J), Mng. Dir., Ajinomoto, Fugitive
Masaru Yamamoto (J), Div. Mgr., Kyowa, $50,000
Jhom Su Kim (SK), Pres., Sewon America, 75,000

10
Lysine buyers
• individual U.S. buyers received
compensation ≈ their losses
• that is, they did not get treble damages
• total U.S. corporate settlements: about $85
million
Mergers
• if antitrust or competition laws prevent
firms from colluding, they may try to merge
• U.S. laws restrict ability of firms to merge if
effect would be anticompetitive
Some mergers raise efficiency
• efficiency due to greater scale
• sharing trade secrets
• closing duplicative retail outlets
Chase and Chemical banks merged in 1995:
closed or combined 7 branches in Manhattan
located within 2 blocks of another branch
Airline mergers
• government did not contest most airline
mergers 1985-1988
• prices increased on routes served by firms
that merged relative to those on routes
without mergers
Soft drinks 1986 merger
proposals
• Coke, largest carbonated soft drinks producer
(38.6% of sales), tried to buy 3rd largest, Dr
Pepper (7.1%)

• Pepsi, 2nd largest producer (27.4%), tried to
acquire 4th largest firm, Seven-Up Co. (6.3%)
• had these proposed mergers taken place, Coke's
market share would have risen to 45.7% and
Pepsi's to 33.7%
• combined share would have risen from 66.0% to
79.4%
FTC intervenes
Federal Trade Commission (FTC) opposed
mergers, arguing that merger
• would increase market shares of big firms
• make entry of new firms more difficult
• raise costs of other companies doing
business in this market
• ease "collusion among participants in the
relevant markets"
11
Relevant market definition
• Coca-Cola: all beverages including tap
water
• Federal Judge Gesell: carbonated soft drinks
(based on cross-elasticities of demand)
Outcome
• after FTC blocked Coke and Pepsi mergers in
1986
• Dr Pepper Co. sold for $416 million to investor group
($54 million less than Coke offered)
• Seven-Up Co. sold for $240 million to another
investment group ($140 million less than Pepsico's bid)
• lower values to others than to Coke and Pepsi is

consistent with FTC's view that Coke and Pepsi
would have gained market power through these
mergers
Eventually
• Dr Pepper and Seven-Up merged
• by 1995: Dr Pepper/Seven-Up: 11.5% of carbonated
beverages market
• Cadbury: 5.5% [Schweppes, Canada Dry, Crush,
Sunkist, and A&W (root beer) brands]
• Cadbury bought Dr Pepper/Seven-Up (17% of soft-
drink market, and half non-cola part)
• Coke: 41%, Pepsi: 32%
• mergers increased share of top 3 firms
• FTC's actions limited share of top 2 firms
Noncooperative oligopoly
• many models of noncooperative oligopoly
behavior
• firms choose quantities
• Cournot model
• Stackelberg model
• firms set prices: Bertrand model
Cournot
• Augustin Cournot introduced first formal model of
oligopoly in 1838
• oligopoly firms choose how much to produce at
same time
• as in prisoners' dilemma game, firms are playing
noncooperative game of imperfect information
• each firm chooses its output level before knowing what
other firm will choose

• firms may choose any output level they want
Basic model
• duopoly: 2 firms (no other firms can enter)
• firms sell identical products
• market that lasts only 1 period (product or
service cannot be stored and sold later)
12
Cournot model of airline market
• duopoly: United Airlines (UA) and
American Airlines (AA) fly passengers
between Chicago and Los Angeles
• no possible entry (limited landing rights at
both airports)
Cournot equilibrium
• Nash equilibrium where firms choose
quantities
• set of quantities sold by firms such that,
holding quantities of all other firms
constant, no firm can obtain a higher profit
by choosing a different quantity
Figure 13.2a American Airlines’ Profit-Maximizing Output
p, $ per
passenger
MC
MR
D
(a) Monopoly
q
A
, Thousand American Airlines

passengers per quarter
339
147
243
0 339169.596
Figure 13.2b American Airlines’ Profit-Maximizing Output
MR
r
D
r
D
p, $ per
passenger
MC
(b) Duopoly
q
A
, Thousand American Airlines
passengers per quarter
q
U
= 64
339
147
275
211
0 339275137.564 128
Figure 13.3 American and United’s Best-Response Curves
q
U

, Thousand United
passengers per quarter
United
’
s best-response curve
Cournot equilibrium
American’s best-response curve
q
A
, Thousand American
passengers per quarter
192
64
48
96
0 1929664
Figure 13.4a Duopoly Equilibria
Price-taking equilibrium
q
U
, Thousand United
passengers per quarter
United’s best-response curve
Cournot equilibrium
Cartel
equilibrium
Stackelberg equilibrium
Contract
curve
American’s best-response curve

(a) Equilibrium Quantities
q
A
, Thousand American passengers per quarter
192
64
48
96
0 192966448
13
Figure 13.4b Duopoly Equilibria
π
U
, $ million profit
of United Airlines
Cournot profits
Price-taking profits
Profit possibility frontier
Cartel profits
Stackelberg
profits
American monopoly
profit
(b) Equilibrium Profits
π
A
, $ million profit of American Airlines
9.2
4.1
2.3

4.6
09.24.64.1
Algebraic approach
• estimate of linear market demand function is
Q(p) = 339 – p
• linear residual demand facing AA is
q
A
= Q(p) –q
U
= (339 – p) –q
U
⇒
p = 339 - q
A
-q
U
• slope of residual demand curve is ∆p/∆q
A
= -1,
so slope of MR
r
= -2
MR
r
= 339 - 2q
A
-q
U
Calculus

• linear residual demand facing AA is
p = 339 - q
A
–q
U
• so AA’s revenue is
R = 339q
A
- q
A
2
-q
U
q
A
• so AA’s marginal revenue (using the
Cournot assumption) is
MR
r
= dR/dq
A
= 339 – 2q
A
-q
U
AA Maximizes profit
MR
r
= 339 - 2q
A

-q
U
= 147 = MC
⇒ best-response function
q
A
= 96 - ½ q
U
Cournot equilibrium
• intersection of best-response functions
q
A
= 96 - ½ q
U
q
U
= 96 - ½ q
A
• solve by substituting
q
A
= 96 - ½(96 - ½ q
A
)
⇒ q
A
= 64
Q = q
A
+ q

U
= 128
p = 339 – Q = $211
Solved problem
• Math version of Solved Problem 13.1 in text.
• Government charges American Airlines and
United Airlines a specific tax of τ per passenger
on the Los Angeles-Chicago route.
• What is the new equilibrium number of passengers
that each airline flies?
• What's the equilibrium number if the tax is $30?
14
Answer
• determine how the firms' best-response functions
change due to the tax:
• AA sets its MR
r
equal to its MC (including the
tax)
MR
r
= 339 - 2q
A
- q
U
= 147 + τ = MC
• rearranging, AA’s best-response function is
q
A
= 96 - τ/2 - q

U
/2
• similarly, UA's best-response function is
q
U
= 96 - τ/2 - q
A
/2
Answer (cont.)
• solve for the equilibrium quantities in
terms of τ:
• substitute UA's best-response function
into AA's and rearrange:
q
A
= (2/3)(96 – τ/2) = 64 – τ/3
• substitute for q
a
in UA's best-response
function:
q
U
= 64 – τ/3
Answer (cont.)
solve for the equilibrium quantities where
τ= $30:
q
A
= q
U

= 64 – [1/3]τ = 54
European cigarette tax incidence
• As with a monopoly, an oligopoly may pass through less
or more than 100% of a tax to consumers
• Delipalla and O’Donnell’s (2001) estimate degree of pass-
through to consumers from a specific tax on cigarettes:
• < 100%: Netherlands (67%), Belgium (79%), and
Germany (82%)
• ≈ 100%: Denmark, U.K., Portugal, and Ireland
• extremely high: Italy (359%), France (604%),
Luxembourg (700%)
Cournot equilibrium varies with
number of firms
• typical Cournot firm maximizes its profit
MR = p(1 + 1/[nε]) = MC
• nε is elasticity of residual demand curve facing
each firm
• ε is market elasticity of demand
• n is number of firms
• Lerner index:
1
p
MC
p
n
ε
−
=−
15
Air ticket prices and rivalry

• markup of price over marginal cost is much
greater on routes in which one airline carries most
of the passengers than on other routes
• a single firm is the only carrier or the dominate
carrier on 58% of all U.S. domestic routes
• monopoly serves 18% of all routes
• duopolies 19%
• 3 firms 16%
• 4 firms 13%
• 5+ firms 35%
Air ticket prices (cont.)
• although nearly two-thirds of all routes have three
or more carriers, one or two firms dominate
virtually all routes
• dominant firm: has at least 60% of ticket sales by value
but is not a monopoly
• dominant pair if they collectively have at least 60% of
the market but neither firm is a dominant firm and three
or more firms fly this route
• all but 0.1% of routes have a monopoly (18%), a
dominant firm (40%), or a dominant pair (42%)
Air ticket prices (cont.)
• (average price includes “free” frequent flier tickets
and other below-cost tickets)
• ticket price is
• 2.1 x MC on average across all U.S. routes and market
structures
• 3.3 x MC for monopolies
• 3.1 x MC for dominant firms
• 1.2 x MC for dominant pairs

• if there is a dominant pair, whether there are 4 or 5
firms, price is between 1.3 x MC for a 4-firm route
and 1.4 x for a route with 5 or more firms
Stackelberg model
• Cournot model: both firms make their
output decisions simultaneously
• Heinrich von Stackelberg's model: firms act
sequentially
• leader firm sets its output first
• then its rival (follower) sets its output
Figure 13.5 Stackelberg Game Tree
American
64
96
48
(4.6, 4.6)
(3.8, 5.1)
(2.3, 4.6)
48
Leader’s decision Follower’s decision Profits (
π
A
,
π
U
)
64
96
48
(5.1, 3.8)

(4.1, 4.1)
(2.0, 3.1)
64
64
96
48
(4.6, 2.3)
(3.1, 2.0)
(0, 0)
96
United
United
United
Figure 13.6
Stackelberg Equilibrium
q
U
, Thousand United
passengers per quarter
q
A
, Thousand American passengers per quarter
q
U
= 48
96
0 q
A
= 96
MR

r
D
r
D
MC
p, $ per
passenger
(a) Residual Demand American Faces
q
A
, Thousand American passengers per quarter
q
U
= 48
339
195
243
147
0 339192
192
q
A
= 96 Q = 144
United
’
s best-response curve
(b) United’s Best-Response Curve
16
Question
• when firms move simultaneously,

• why doesn't AA announce it will produce
Stackelberg-leader output,
• so as to induce UA to produce the
Stackelberg follower's output level?
Answer
when firms move simultaneously, UA doesn't
view AA's warning that it will produce a large
quantity as a credible threat:
• not in AA’s best interest to produce large quantity
• because AA cannot be sure that UA believes threat
and reduce its output, AA produces Cournot level
• when one firm moves first, its threat to produce
large quantity is credible because it has already
committed to producing large quantity
Monopolistic competition
• market structure in which firms
• have market power
• are price setters
• firms enter if there is a profit opportunity (π = 0)
• monopolistically competitive equilibrium:
MR = MC
p = AC (demand curve tangent to AC curve)
Figure 13.8 Monopolistically Competitive Equilibrium
p, $ per unit
q, Units per yearq
p
MR
r
D
r

MC
AC
p = AC
MR
r
= MC
Figure 13.9a Monopolistic Competition Among Airlines
p, $ per
passenger
275137.5640
q, Thousand passengers
per quarter
300
275
211
183
147
(a) Two Firms in the Market
AC
MC
MR
r
for 2 firms
π
= $1.8 million
D
r
for 2 firms
if F = $2.3 million
Figure 13.9b Monopolistic Competition Among Airlines

p, $ per
passenger
243121.5480
q, Thousand passengers
per quarter
300
243
195
147
(b) Three Firms in the Market
AC
MC
MR
r
for 3 firms
D
for 3 firms
r
17
Number of firms
• number of firms in equilibrium is smaller,
• greater economies of scale
• less market demand at each price
• fewer monopolistically competitive firms,
• less elastic is each firm’s residual demand
curve at equilibrium
• higher fixed cost
Fixed cost and number of firms
• fixed costs determine number of firms
AC = 147 + F/q

• smallest quantity at which AC curve reaches its
minimum called
• full capacity, or
• minimum efficient scale
• monopolistically competitive equilibrium in
downward-sloping section of AC curve, so
monopolistically competitive firm operates at less
than full capacity in LR
Bertrand
• firms set price instead of quantity
• changes equilibrium
• (unlike monopoly, choice of quantity vs.
price matters)
Figure 13.10 Bertrand Equilibrium with Identical Products
p
2
, Price of Firm 2,
$ per unit
Firm 2
’s best-response curve
Firm 1
’
s best-response curve
45° line
e
p
1
, Price of Firm 1, $ per unit
10
5

05109.99
Figure 13.11 Bertrand Equilibrium with Differentiated Products
p
c
, Price of Coke,
$ per unit
Pepsi’s best-response
curve (MC
p
= $5) Coke’s best-response
curve (MC
c
= $14.50)
Coke’s best-response
curve (MC
c
= $5)
p
p
, Price of Pepsi, $ per unit
25
18
13
02513 14
e
1
e
2
1. Market structure
• prices, profits, and quantities in a market

equilibrium depend on the market's structure
• all firms maximize profit by setting MR = MC
• oligopolies and monopolistically competitive
firms are price setters: face downward-sloping
demand curves
• oligopoly: entry blocked
• monopolistic competition: free entry
18
2. Game theory
• set of tools used to analyze conflict and
cooperation between firms
• each firm forms a strategy or battle plan of the
actions to compete with other firms
• firms' set of strategies is a Nash equilibrium if,
• holding the strategies of all other firms constant,
• no firm can obtain a higher profit by choosing a
different strategy
3. Cooperative oligopoly models
• with collusion, firms collectively produce
monopoly output and earn monopoly profit
• each individual firm has an incentive to
cheat on a cartel arrangement so as to raise
its own profit even higher
4. Cournot model of
noncooperative oligopoly
• if oligopoly firms act independently, market
output and firms' profits lie between competitive
and monopoly levels
• Cournot model: each oligopoly firm sets its output
simultaneously

• Cournot (Nash) equilibrium: each firm produces
its best-response output given rivals’ outputs
• as number of Cournot firms increases, Cournot
equilibrium price, quantity, and profits approach
price-taking levels
5. Stackelberg model of
noncooperative oligopoly
• Stackelberg leader chooses its output first
• then its rivals - Stackelberg followers –
choose outputs
• leader produces more and earns a higher
profit than followers
6. Monopolistic competition
• monopolistically competitive firms are price
setters: MR= MC, so p > MC
• there's free entry: p = AC