• Oligopoly market structures are characterized by only a few firms, each of which is large relative to the total industry. – Typical number of firms is between 2 and 10. – Products can be identical or differentiated. • An oligopoly market composed of two firms is called a duopoly. • Oligopoly settings tend to be the most difficult to manage since managers must consider the likely impact of his or her decisions on the decisions of other firms in the market.
Sweezy Oligopoly Sweezy oligopoly characteristics: • There are few firms in the market serving many consumers. • The firms produce differentiated products. • Each firm believes its rivals will cut their prices in response to a price reduction but will not raise their prices in response to a price increase. • Barriers to entry exist.
Cournot Oligopoly Cournot oligopoly characteristics • There are few firms in the market serving many consumers. • The firms produce either differentiated or homogeneous products. • Each firm believes rivals will hold their output constant if it changes its output. • Barriers to entry exist.
Profit Maximization in Four Oligopoly Settings Cournot Oligopoly: Reaction Functions • Consider a Cournot duopoly. Each firm makes an output decision under the belief that is rival will hold its output constant when the other changes its output level. – Implication: Each firm’s marginal revenue is impacted by the other firms output decision. • The relationship between each firm’s profit- maximizing output level is called a best- response or reaction function.
• Markets with only a few dominant firms can coordinate to restrict output to their benefit at the expense of consumers. – Restricted output leads to higher market prices. • Such acts by firms is known as collusion. • Collusion, however, is prone to cheating behavior. – Since both parties are aware of these incentives, reaching collusive agreements is often very difficult.
• Consider the following inverse market demand function: 𝑃 = 1,000 − 𝑄1 + 𝑄2 and the cost function for each firm in this market is identical, and given by 𝐶𝑖 𝑄𝑖 = 4𝑄𝑖 • Under these condition, the different oligopoly outputs, prices and profits are examined.
• Since the output associated with collusion is the same as monopoly output, the inverse market demand function implies that monopoly marginal revenue function is: 𝑀𝑅 = 1,000 − 2𝑄 • Setting marginal revenue equal to marginal cost yields: 1,000 − 2𝑄 = 4 – Solving this: 𝑄 = 498 units. Each firm will produce half of these units. • Price is: 𝑃 = 1,000 − 498 = $502 • Each firm earns profits of $124,002.
