BEE2017, Microeconomics 2, Dieter Balkenborg

Cournot Oligopoly with n rms

rm is output: qi total output: q = q1 + q2 + + qn opponents output: qi = q qi = j=i qi constant marginal costs of rm i: ci inverse demand function: p (q) rm i s prot: i (qi , qi ) = p (q) qi ci qi = (p (qi + qi ) ci ) qi FOC for prot maximum given qi : p i = qi + p ci = 0 qi qi Solution denes reaction curve qi = ri (qi ) which is often decreasing in qi . Linear case: p = A Bq = A B (qi + qi )

3 2.5

p
2 1.5 1 0.5

0.5

1.5

2.5

q
p = B qi FOC: Bqi + (A B (qi + qi )) ci 2Bqi Reactionfunction qi = ri (qi ) = = 0 = A ci Bqi

Ac 1 qi 2B 2

10

q1= r1(q2) CournotNash q2= r2(q1)

2 4 6

q26
4

q1

Cournot-Nash equilibrium: 1. Every rm maximizes prot given her expectation of qi . 2. The expectation is correct. This yields the simultaneous system of equations qi = ri (qi ) for all i = 1, . . . , n. In the linear case the FOC yields, since qi + qi = q Bq1 + (A Bq) c1 Bq2 + (A Bq) c2 = 0 = 0 . . . = 0

Bqn + (A Bq) cn Summation yields

Bq + n (A Bq) n = 0 c where c= c1 + c2 + + cn n

is the average marginal cost in the market. Thus we can deduce the total quantity produced and the price in the market (n + 1) Bq q = n (A c) n Ac = n+1 B 1 n A+ c c for n n+1 n+1

p = A Bq =

Each rm produces in the n-rm oligopoly

n qi =

A Bq ci A ci n Ac 1 A n ( ci ) ci c = = + . B B n+1 B n+1B (n + 1) B

Let us now, for simplicity, assume that rms have identical marginal costs ci = c = c. Then p =
n qi

n i nn i

n 1 A+ c c as n n+1 n+1 1 Ac = 0 as n n+1 B 1 n n = (p c) qi = A+ cc n+1 n+1 = (A c)2 0 as n B (n + 1) n

2

(A c) 2 1 Ac 1 = 2 n+1 B B (n + 1)

The total prot in the industry decreases with every additional rm entering the market since for all n>1
n1 > nn (n 1) i i n1 n > (n)2 (n + 1)2

(n 1) (n + 1)2 > n3 n2 1 (n + 1) > n3 n3 n + n2 1 > n3 n2 > n 1 which is true since n2 > n for all n > 1. In particular, it always pays for the rms to form a cartel and share the monopolist prot since nn < 1 . i i

Stackelberg Equilibrium

Two rms with marginal costs 1. Dierent timing: Firm 1 moves rst, rm 2 observes the move and then adapts. If a rational rm 2 observes the quantity q1 it will choose the quantity q2 = r2 (q1 ) = Total output is q1 + q2 = and the price will be p = A B (q1 + q2 ) = A Anticipating this, rm 1 expects to make the prot 1 (q1 , r1 (q2 )) = which is maximized for q1 = A + c Bq1 A c Bq1 c q1 = q1 2 2 Ac 2B 3 Ac B A + c Bq1 q1 = 2 2 2 Ac 1 q1 2B 2

Ac 1 + q1 2B 2

yielding the price p= and the prot 1 = Firm 2 produces q2 = and makes the prot A + c B Ac Ac 2B = 2 4 1 (A c)2 8 B

Ac 1 Ac q1 = 2B 2 4B

1 1 (A c)2 2 = 1 = 2 16 B Notice that this would not be a Nash equilibrium if rm 2 could not observe the quantity choice because rm 2 reacts optimally while rm 1 should produce q1 = r1 (q2 ) = Total quantity would be
5 Ac 8 B

Ac 1 Ac Ac 3Ac q2 = = 2B 2 2B 8B 8 B

and the the price would reduce to p = A 3A + 5c 5 (A c) = 8 8

2 2

and yield the prot 1 = 3A + 5c c 8 3Ac 8 4B = 1 (A c) 9 (A c) > 2 8 B 8 B

The leader produces in the Stackelberg equilibrium twice as much than the follower and makes twice the 2 prot. In the Cournot duopoly the payo 2 = 1 (Ac) which is in between the prot of the leader and i 9 B the follower.

Bertrand competition with dierentiated products

Q1 Q2 = 100 2P1 + P2 = 100 2P2 + P1

The two rms have the demand functions

and constant marginal costs c = 5. The prot function for rm i is i (p1 , p2 ) = (Pi c) Qi = (Pi 5) (100 2Pi + Pj ) where j = 3 i. The rst order condition for a prot optimum (taking the other rms price as given) is i = (+1) (100 2Pi + Pj ) + (Pi 5) (2) = 110 4Pi + Pj = 0, i = 1, 2 Pi The solution to this system of equations is P1 = P2 = 110 = 36 2 . Each rm produces 2110 = 73 1 units 3 3 3 3 and makes the prot 73 1 36 2 2688 2 is made. Together they make the prot 5376. If they would 3 3 form a cartel they could make the prot 1 (p1 , p2 ) + 2 (p1 , p2 ). Maximizing joint prot leads to the two rst order conditions (1 + 2 ) = 110 4Pi + Pj + (Pi 5) = 105 3Pi + Pj = 0, i = 1, 2 Pi which have the solution P1 = P2 = 52.5. Of each commodity 57.5 units are produced and the total prot is 2 47 1 57 1 = 5462.5, which is obviously higher than in competition. 2 2 4

Bertrand competition with perfect complements.

Two price-setting rms produce with constant marginal costs c = 3 produce goods which are perfect complements. Consumers therefore buy equal amounts from both rms. The total amount they by of each commodity is Q = Q (P1 , P2 ) = 15 (P1 + P2 ) The prot of rm i = 1 or i = 2 is i (P1 , P2 ) = (Pi 3) Q = (Pi 3) (15 (P1 + P2 )) The rst-order condition for a prot maximum is i = 15 (P1 + P2 ) (Pi 3) = 18 2Pi Pj = 0 Pi where j = 3 i. By symmetry, P1 = P2 in equilibrium, so 3Pi = 18 or P1 = P2 = 6. It follows that Q = 15 12 = 3 pairs are sold at the price 6. Each rm makes the prot (6 3) 3 = 9 and the total prot in the industry is 18. If a monopolist takes over both plants and takes the price 2P per pair his prot is (P ) = (2P 6) (15 2P ) which is maximized for 2P = 15+6 = 10.5 where 15 10.5 = 4.5 pairs are demanded. Consumer surplus 2 is up in the monopoly because they get more at a lower price. Producer surplus goes up because the monopolists prot is 4.52 = 20. 25 > 18.