Oligopoly Models Overview

Oligopoly Models

• Sweezy Model (Kinked Demand Curve): Products/services are differentiated, prices are sticky (infrequently change). Competitors react to price changes, keeping prices fixed. If one firm cuts prices, competitors usually match. If one firm raises prices, competitors won't follow, causing a steep demand curve. A "kink" emerges, leading to price rigidity. More elastic demand means a flatter curve.

• Cournot Model (Duopoly): In this model of a duopoly (two firms), each firm anticipates its competitor's output when deciding its output level. This creates a reaction function. The market inverse demand function is used to determine price based on total output (from both firms).

• Bertrand Model (Duopoly): This model assumes firms compete in prices. The reaction function for each firm is to produce at prices as low as possible to attract customers.

• Stackelberg Model (Duopoly): One firm is a leader, the other a follower. The leader assumes the follower will adjust to its actions. The leader's output determines the follower's output. This model of duopoly analyzes the outcome.

Contestable Markets

• Contestable markets: all players have equal access to the market—information, resources. Existing and new firms can enter and leave easily with no barriers to entry and exit.
• In a contestable market, firms have no market power. No significant barriers are present, to entry.
• If firms earn economic profits, competitors enter until firms earn zero economic profits because the existing firms may not be able to maintain high prices due to competition.

Cartel

• Cartel: A group of companies that collude to manipulate supply or prices to increase profits.
• Collusion: When firms agree to limit output and raise prices.
• Often found in situations where there is inelastic demand, meaning a price change doesn't greatly impact demand. Example, OPEC (Organization of the Petroleum Exporting Countries).
• There are often issues with cartelization because there is an incentive for members of the cartel to cheat and create more product than agreed upon to gain market share and profits, thus breaking up the cartel or preventing it from forming in the first place.

General Concepts

• Homogeneous products: Products that are identical across firms.
• Differentiated products: Products that are slightly different across firms.
• Barriers to entry: Obstacles that prevent new firms from entering the market.
• Sunk costs: Costs that are unrecoverable.
• Marginal Revenue (MR) Curve: The change in total revenue that results from an additional unit sold relative to the marginal cost(MC). A key relationship in finding profit maximization for different firm structures.
• Monopoly: One firm dominates the market.
• Perfect Competition: Many firms, homogeneous products.