Microeconomics Chapter 3: Oligopoly Models

Understanding Oligopoly Models

• Oligopoly is characterized by a small number of large firms, leading to interdependence in decision-making.
• In oligopoly, each firm's actions depend on its conjecture about rivals' reactions, influencing decisions on pricing and output.

Conjectural Variation

• Firms in oligopoly must estimate how rivals will respond to their actions, known as conjectural variation.
• Conjectural variation shapes firms' strategies, as seen in the Cournot model.

Extremes in Oligopoly

• Oligopoly can be viewed through two extremes: pure independent action and pure collusion.
• Pure independent action involves unilateral decisions by firms, while pure collusion entails coordinated actions among rivals.

Cournot Model

• In the Cournot model, firms compete by setting quantities.
• Equilibrium occurs when firms' expectations about rivals' outputs align with reality, leading to consistent market prices.

Bertrand Model

• The Bertrand model focuses on price competition, where each firm sets its price to capture market share.
• Equilibrium often results in competitive pricing, similar to perfect competition.
• In homogeneous markets, firms may compete aggressively on price, leading to prices converging towards marginal costs.

Implications of Bertrand Competition

• The Bertrand model is relevant in industries like airlines, where price competition is intense.

Hotelling Model

• The Hotelling model explores horizontal differentiation, where firms' locations along a linear market affect consumer choices.
• Equilibrium locations are determined by balancing proximity to consumers with competitive advantage.

Principle of Minimum Differentiation

• Under the Hotelling model, firms may choose locations to minimize differentiation, leading to spatial clustering and limited competition based on location.