Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

250 PRICE AND OUTPUT UNDER MONOPOLISTIC COMPETITION AND OLIGOPOLY [CHAP. 10
(4) Even in markets in which there are many small sellers of a good or service (say, gasoline stations) a change in
price by one of them affects nearby stations significantly and evokes a response. In such cases, the oligopoly
model is the more appropriate model to use.
Despite these serious criticisms, however, the monopolistic competition model provides some important insights,
such as its emphasis on product differentiation and selling expenses, that are applicable to oligopolistic markets.
OLIGOPOLY DEFINED
10.9 (a) Define oligopoly. (b) What is the single most important characteristic in oligopolistic markets and
(c) to what problem does it lead? (d) What does oligopoly theory achieve?
(a) Oligopoly is the form of market organization in which there are few sellers of a commodity. If there are only
two sellers, we have a duopoly. If the product is homogeneous (e.g., steel, cement, copper), we have a pure
oligopoly. If the product is differentiated (e.g., cars, cigarettes), we have a differentiated oligopoly. For simplicity,
in the text and in that which follows we deal mostly with a pure duopoly. Oligopoly is the most prevalent
form of market organization in the manufacturing sector of modern economies and arises for the same
general reasons as monopoly (i.e., economies of scale, control over the source of raw materials, patents,
and government franchise).
(b) The interdependence among the firms in the industry is the single most important characteristic setting oligopoly
apart from other market structures. This interdependence is the natural result of fewness. That is, since
there are few firms in an oligopolistic industry, when one of them lowers its price, undertakes a successful
advertising campaign, or introduces a better model, the demand curve faced by other oligopolists will shift
down. So the other oligopolists react.
(c) There are many different reaction patterns of the other oligopolists to the actions of the first, and unless and
until we assume a specific reaction pattern, we cannot define the demand curve faced by our oligopolist. So we
have an indeterminate solution. But even if we assume a particular reaction pattern so that we may have a
determinate solution, this is only one out of many possible solutions.
(d ) Because of the situation outlined in (c), we do not now have a general theory of oligopoly. All we have are
specific cases or models, a few of which are discussed in Sections 10.6 to l0.11. These few models, however,
do accomplish three things: (1) they show clearly the nature of oligopolistic interdependence, (2) they point
out the gaps that a satisfactory theory of oligopoly must fill, and (3) they give some indication as to how very
difficult this branch of microeconomics really is and how long we may have to wait to get a general theory of
oligopoly. In short, oligopoly theory is one of the least satisfactory segments of microeconomics.
THE COURNOT, BERTRAND, AND EDGEWORTH MODELS
10.10 Assume that (1) there are only two firms, A and B, selling a homogeneous commodity produced at zero
cost, (2) the total market demand function for this commodity is given by QD ¼ 240 2 10P, where P is
given in dollars, and (3) firm A enters the market first, followed by firm B, but each always assumes, in
determining its best level of output, that the other will hold output constant.
With reference to the above, (a) show with the aid of a diagram how duopolists A and B reach the
equilibrium point. (b) What price will each charge when in equilibrium? How does this compare with
the monopoly price? With the perfectly competitive price? (c) What quantity will each produce when in
equilibrium? How does this compare with the monopoly output? With the perfectly competitive output
(d) How much profit will each duopolist make when in equilibrium? How does this compare with the
monopoly profits? With the case of perfect competition? (e) What would happen to the equilibrium
industry output and price if one more firm entered this industry? If many more firms came in?
(a)
Assumptions 1, 2, and 3 given in this problem define the Cournot model. The way duopolists A and B reach
their equilibrium point is shown in Fig. 10-13. Before duopolist B enters the market, duopolist A will maximize
total profits at point A on D ¼ d A . This is the monopoly solution. When duopolist B enters the industry, B
will sell at point B on d B . Duopolist A reacts by selling at point A 0 on dA 0 . The process will continue until each
duopolist will be in equilibrium at point E on d E .