Oligopoly and Strategic Interdependence

An oligopoly has a small number of important firms. Products may be homogeneous, as in basic materials, or differentiated, as in smartphones and airlines. The defining feature is strategic interdependence: each firm's payoff and best action depend on what rivals do.

A price cut may win customers but trigger matching cuts. Added capacity can lower market price and change rivals' output. Research, compatibility, store locations, and advertising can all provoke responses.

A quantity-choice model

In a Cournot model, firms choose quantities simultaneously. Market price depends on total output $Q=q_1+q_2$. Firm 1's profit is

Its best-response function gives the profit-maximizing $q_1$ for every possible $q_2$. More rival output usually lowers firm 1's best response because total output depresses price.

The intersection of best responses is a Cournot-Nash equilibrium. Neither firm wants to change quantity alone. In the standard model, total output is greater and price lower than monopoly, but output is below and price above perfect competition.

Models depend on the strategic variable

Cournot uses quantity. Bertrand models use price and can produce intense competition for homogeneous products. Capacity, timing, differentiation, and repeated interaction can substantially change predictions. Choose a model that matches what firms actually commit to and what can be adjusted quickly.

Market concentration suggests strategic interaction but does not determine conduct by itself. Entry threats, buyer power, contracts, and regulation also matter.

Solve two best responses

Let $P=30-q_A-q_B$ and MC equal 6. Firm A's profit is $(24-q_A-q_B)q_A$. Maximizing with respect to its own quantity gives $q_A=(24-q_B)/2$. Firm B has the symmetric response.

At the intersection, both choose 8, total output is 16, price is 14, and each earns 64. If B instead commits to 6, A's best response rises to 9. A strategy that is best in one rival scenario need not remain best in another.

Compare competition and coordination

Acting together as a monopolist, the firms would choose total output 12. Splitting it equally gives six each and profit 72 each. Yet when B stays at six, A can deviate to nine and earn 81. The jointly better agreement contains its own incentive to break.

Before applying an oligopoly model, identify the strategic variable and timing. Capacity chosen months ahead differs from prices changed daily. The model should reflect what firms commit to before observing rivals.