Econ 4001.01 1st Edition Lecture 21Outline of Last Lecture II. Basics of Monopolistic CompetitionIII. Long-Run vs. Short-run in Monopolistic CompetitionIV. Monopolistic Competition vs. Perfect CompetitionV. Welfare Impacts of Monopolistic CompetitionVI. Advertising and Monopolistic CompetitionVII. Pros and Cons of AdvertisingVIII. Strategic Behavior between FirmsOutline of Current Lecture IX. Oligopoly X. Behavior in OligopolyXI. Oligopoly in Strategic EquilibriumXII. Cournot Modela. Example of Cournot Model with Numbersb. Additional Information about Cournot ModelsXIII. Stackleberg ModelXIV. Bertrand Price CompetitionXV. Oligopoly and Game theoryCurrent Lecture- Oligopolyo Only a few sellerso Offer similar or identical productso Barriers to entry offer them market powero Interdependent in their pricing and quantities- Behavior in Oligopolyo Two polar extremes are possible Act like a single monopolist and share market Compete with rival firms in the market- Oligopoly Strategic Interaction and Equilibriumo Assumption: Oligopoly firms choose a strategy (setting a price or quantity) in order to maximize profitso Two definitions Nash Equilibrium: A set of strategies in which each firm does the best it can given its competitors’ actionsThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. Dominant Strategy: A set of strategies in which each firm’s behavior is at the most optimum despite the other competitors- The Cournot Modelo Antoine Cournot was a French mathematician and pioneer in understanding of economic behavioro Initial example: two firms have access to a mineral spring, they need to decide how much spring water to sell in the marketo The good is homogeneous, and firms have to make a costly investment to produce and expand production - Example of the Cournot Model with Numberso Consider a duopoly with firms A and Bo If equation for demand is Q= 50-Po We can rearrange this to P=50-QA-QBo Suppose MCA= MCB= 10o We want to find MR curve for firm A. We know with linear demand that MR curve has same price intercept as demand curve and is twice as steep MRA= 10=(50-QB)-2QA We can rearrange this to QA= 20-(1/2 Qa) This equation is the same for QB Overall can reduce this to 3/4QA=10 or QA=13.33o Profit= (P-MC)*Q (23.3-10)*13.3= $178o Cournot (reaction) Curve is a representation of quantities of two different firms/where they intercept is the Cournot equilibrium- Additional Information about Cournot Modelso Analysis can be extended to three or more firms, with reaction functions for eachfirmo Equilibrium price is lower and total quantity higher as number of firms increases- Stackelberg Model-One Firm Moves Fasto If one of the firms can make it’s decision first, does that change the equilibrium?o The first mover advantage allows it to choose a higher quantity and crowd out the other firmo This is exactly what happenso Formulation of Demand Consider a duopoly with firms A and B, and A is lower Use the same Cournot curves for each, so both are 20-(1/2 QA) Now Firm A can use this information directly- this reaction is plugged into the demand curve P=50-Qa-Qb so if you plug in the other numbers you get P=50-Qz-(20-1/2Qa) Reduce it to P=30-1/2Qa P=50-Q= $20 Plug this price into the profit equation for each of the firms and you will get Firm A’s profit as $200 and Firm B’s profit will be $100- Bertrand- Price Competitiono Competitors compete on price rather than quantityo Essential- each Bertrand competitor can serve the entire market if its price is lowesto Result-ruthless price competition cuts prices down to marginal cost; consumers are best off, firms do not make profits- Oligopoly and Game Theoryo Prisoner’s Dilemma- simple non-cooperative gameo Formal Structure: Each player can cooperate or defect What is the best option? A dominant strategy exists, which is better than the Nash Equilibrium, butthe two prisoners will most likely end up in Nash Equilibrium Collusion- leads to higher prices and