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Imperfect Competition
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Outline
1What Does Equilibrium Mean in an
Oligopoly?
2Oligopoly with Identical Goods:
Collusion and Cartels
3Oligopoly with Identical Goods:
Bertrand Competition
4Oligopoly with Identical Goods:
Cournot Competition
5Oligopoly with Identical Goods:
Stackelberg Competition
6Oligopoly with Differentiated Goods:
Bertrand Competition
7Monopolistic Competition
8Conclusion
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Introduction
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Markets rarely fit all of the assumptions of perfect competition or
monopoly
In this chapter, we explore market structures that are collectively
referred to as imperfect competition
•Market structures with characteristics between those of perfect competition
and monopoly
We relax a number of assumptions to examine markets in a more
realistic manner
•Allow for varying degrees of competition
•Allow for differentiated products
•Allow for strategic behavior
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The situation described in the previous example means that there is an
incentive for firms to engage in collusion or to form a cartel
•Oligopoly behavior in which firms coordinate and collectively act as a
monopoly to gain monopoly profits.
Model Assumptions: Collusion and Cartels
•Firms make identical products
•Industry firms agree to coordinate their quantity and pricing decisions
• No firm deviates from the agreement, even if breaking it is in the firm’s best
self-interest
Oligopoly with Identical Goods:
Collusion and Cartels
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Oligopoly with Identical Goods:
Collusion and Cartels
Figure 1 Cartel Instability
Price
($/unit)
$20
12
4
MC
MR D
0Quantity
8 9
Cartel members would maximize joint
profits by acting like a monopoly.
Firm A , however, has
an incentive to cheat on
the agreement and
produce another unit of
output.
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What Makes Collusion Easier?
A number of things can make it easier to sustain collusive agreements
•Make easy to detect and punish cheaters
•Little variation in marginal costs across producers –since the goal is to
produce at lowest cost, it is difficult to share profits if production costs vary
greatly across cartel members
•Long time horizon (makes defection more costly, as future monopoly profits
are given more weight)
Oligopoly with Identical Goods:
Collusion and Cartels
3Oligopoly with Identical
Goods: Bertrand Competition
It describes an oligopoly in which each firm chooses the price of its
product
Strategic interaction ensues, with each firm responding to its rivals’ price
decision
Model Assumptions: Bertrand Competition with Identical Goods
•Firms make identical products
•Firms compete by choosing the price at which they sell their products
•Firms set their prices simultaneously.
Nash Equilibrium of a Bertrand Oligopoly
•Equilibrium occurs when each firm charges the marginal cost of production!
•With identical firms and products, if one firm is charging more than its
marginal cost, the other firm always has an incentive to undercut!
•Even though competition is imperfect, in Bertrand competition, market
equilibrium is identical to perfect competition… identical to perfect competition
and price equals marginal cost
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Oligopoly with Identical
Goods: Cournot Competition
This type of structure is called Cournot competition
•Oligopoly model in which each firm chooses its production quantity
Model Assumptions: Cournot Competition with Identical Goods
•Firms make identical products
•Firms compete by choosing a quantity to produce
•All goods sell for the same price –the market price, which is determined by
the sum of quantities produced by all firms in the market
•Firms choose quantities simultaneously.
4Oligopoly with Identical
Goods: Cournot Competition
