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Lecture 12

Economics 2151B - Lecture 12.docx

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Department
Economics
Course
Economics 2150A/B
Professor
Kristin Denniston
Semester
Winter

Description
Economics 2151B Monday February 24 Lecture 12 Announcements: • Midterms come back next Monday • Homework #3 will be posted either today or tomorrow th o Due March 5 Ch. 13 – Imperfect Competition Recap: 4 Market Structures 1. Perfect Competition (ch. 9 and 10) 2. Monopoly (ch. 11 and 12) 3. Oligopoly 4. Monopolistic Competition 3. Oligopoly Market • There are few firms in the market, which leads to collusion • There is a lot of strategic interaction • Divided into two different types of product markets: a) Homogeneous (identical) markets b) Differentiated (you have some control over its price) 4. Monopolistic Competition • Many firms • Free entry and exit  There can be profits in the short run, but in the long run, profits are 0 (as in perfect competition) • It is characterized by a lot of product differentiation o eg. McDonalds differentiates their hamburgers from Burger King o This is done through advertising and brand names • This is the most common market structure • Examples: Fast food industry, movie industry • These firms have some market power o They are characterized by downward sloping demand and a downward sloping revenue curve Comparing our homogeneous product models through a specific example: • Assume: 1. Market Demand P = a – bQ 2. Firms are identical (symmetry – same cost structure) 3. Marginal cost = 0 for each firm • Compare: o Perfect competition model outcome o Shared monopoly (cartel structure) o Oligopoly models  Cournot – Q setting  Bertrand – P setting  Stackleberg – sequential Q setting • To find MR curve: o Demand: P = a - bQ o MR: MR = a – 2bQ • Set MR = MC o a – 2bQ = 0 o a = 2bQ a o Q = 2b a a • p = a-b( ) = a – 1/2a = 2b 2 o This is the desired goal of a cartel – they want to collude to obtain monopoly profits in the industry • Cournot Duopoly o Q setting o Simultaneous o Homogenous products o Firms choose output to maximize profit, taking output Q of the other firms as given o Demand: P = a-bQ  P = a-b(Q + Q ) 1 2 o Step 1: Firm 1 sees the following residual demand curve:  P = (a-bQ2) – bQ1 o Step 2: Firm 1 max profit  MR 1 MC  (a-bQ2) – 2bQ1= 0 o Step 3: Solve for Q1 = f(Q2)  Firm 1 reaction function: • 2bQ 1 a-bQ 2 a−bQ 2 • Q* 1 2b • This tells us how we should choose output given what we think firm 2 will produce (firm 2 does the same thing) o Step 4: We find the reaction function for firm 2  Because the firms have identical costs, we can use a shortcut. a−bQ 1  Q 2 = 2b o Step 5: To find the cournot equilibrium Q for each firm, we solve ghe 2 reacition functions for the 2 unknowns, Q 1, Q 2  Substitute Q 2 into the reaction function Q1* a−bQ 1  Q 1 = a-b( 2b ) a  Q 1 = 3b a  By symmetry, Q * 2 3b o Questions from page 6 of your notes: o The combined output:  Q = Q1 + Q2 a a = 3b + 3b 2a = 3b 2 a = ( ) 3 b o Market P  P = a-bQ 2a = a – b( ) 3b 2 = a - 3 a a = 3 o The TR for each duopolist:  TR 1 P x Qi  TR 1 P x Q 1 a a = ( 3 )( 3b ) 2 = a 9b o To find the profit that each duopolist makes:
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