Monopolistic Competition- Managerial Economics
Market in which firms can enter freely, each producing its own brand or version of a differentiated product.
2 Key characteristics
Compete by selling differentiated products that are substitutes
Free entry and exit
Short Run
Firm has some market power and faces downward sloping demand curve
Price exceeds marginal cost
When P>AC firms earn positive economic profits
Long Run
Positive economic profits in short run attracts new firms
Firm’s market share falls and demand curve shifts down
P=AC firms earn 0 economic profit
P>MC and 0 economic profits deadweight loss
Market in which only a few firms compete with one another, and entry by new firms is impeded
Oligopoly Environment
Few Firms, MC but lower than monopoly price
Market Demand (homogeneous-product, duopoly)
P=a-b(Q1+Q2)
TR(firm1)=aQ1-b((Q1*Q2)-b(Q1)^2
MR(firm1)=a-bQ2-2bQ1
MR(firm2)=a-bQ1-2bQ2
Therefore, each firms MR depends on its own and its rivals output
Find firm’s Best-response function, MR=MC a-bQ2-2bQ1=MC1 Q1=((a-Mc1)/2b)-(Q2/2)
Similarily Q2=((a-MC2)/2b)-(Q2/2)
Substitute Q2 into Q1 and solve for Q1 Q1*=(a-MC)/3b
Use Q1* to find Q2*
Aggregate output,Q*=Q1*+Q2*
Normal Form Game ( Nash equilibrium)
Nash equilibrium occurs when no player finds it profitable to unilaterally deviate
Point where 2 best-response lines intersect
Bertrand Model
Few firms that sell to many consumers
Firms produce identical products at a constant MC
Each firm independently sets its price
Barriers to entry exist
Bertrand Equilibrium
P1=P2=MC
Cournot vs. Bertrand
Competition may take place over different time frames
Cournot competitors price less aggressively than Bertrand competitors
Bertrand competitors can ‘Business steal’, and meet rising demand, end up with 0 profits
Cournot competitors have set capacity and make production decisions in advance, unlikely to react to fluctuations in rival’s output
Stackelberg Model
Firms move sequentially( leader-follower)
2 Key characteristics
Compete by selling differentiated products that are substitutes
Free entry and exit
Short Run
Firm has some market power and faces downward sloping demand curve
Price exceeds marginal cost
When P>AC firms earn positive economic profits
Long Run
Positive economic profits in short run attracts new firms
Firm’s market share falls and demand curve shifts down
P=AC firms earn 0 economic profit
P>MC and 0 economic profits deadweight loss
Market in which only a few firms compete with one another, and entry by new firms is impeded
Oligopoly Environment
Few Firms, MC but lower than monopoly price
Market Demand (homogeneous-product, duopoly)
P=a-b(Q1+Q2)
TR(firm1)=aQ1-b((Q1*Q2)-b(Q1)^2
MR(firm1)=a-bQ2-2bQ1
MR(firm2)=a-bQ1-2bQ2
Therefore, each firms MR depends on its own and its rivals output
Find firm’s Best-response function, MR=MC a-bQ2-2bQ1=MC1 Q1=((a-Mc1)/2b)-(Q2/2)
Similarily Q2=((a-MC2)/2b)-(Q2/2)
Substitute Q2 into Q1 and solve for Q1 Q1*=(a-MC)/3b
Use Q1* to find Q2*
Aggregate output,Q*=Q1*+Q2*
Normal Form Game ( Nash equilibrium)
Nash equilibrium occurs when no player finds it profitable to unilaterally deviate
Point where 2 best-response lines intersect
Bertrand Model
Few firms that sell to many consumers
Firms produce identical products at a constant MC
Each firm independently sets its price
Barriers to entry exist
Bertrand Equilibrium
P1=P2=MC
Cournot vs. Bertrand
Competition may take place over different time frames
Cournot competitors price less aggressively than Bertrand competitors
Bertrand competitors can ‘Business steal’, and meet rising demand, end up with 0 profits
Cournot competitors have set capacity and make production decisions in advance, unlikely to react to fluctuations in rival’s output
Stackelberg Model
Firms move sequentially( leader-follower)