MICROECONOMICS

CHAPTER 13
Market Structure & Competition

📚 MASTER STUDY NOTES

Comprehensive Exam Preparation Guide
Academic Year 2025–2026

Part I Study Notes Part II Revision Sheet Part III Exam Predictor

PART I — COMPREHENSIVE STUDY NOTES

I. INTRODUCTION TO MARKET STRUCTURES

1. What Is a Market Structure?

A market structure describes the organizational and competitive characteristics of a market. It
determines how firms behave, how prices are set, and how much economic profit firms can earn.

1.1 Two Key Dimensions

Market structures differ along two critical dimensions:
• Number of firms — Is the market served by one firm, a few, or many?
• Nature of product differentiation — Are products identical or differentiated?

1.2 Types of Products

HOMOGENEOUS PRODUCTS HETEROGENEOUS PRODUCTS

• Virtually identical products • Products are less than perfect substitutes
• Differ in attributes, performance, packaging,
 • Consumers view them as perfect substitutes branding
• Example: salt, steel, wheat • Examples: cars, cola drinks, smartphones
• Price is the only differentiating factor • Firms have pricing power due to
differentiation

1.3 The Four Market Structures — Full Classification Table

The following table classifies all major market structures by number of firms and product type:

Number of Firms Product Type Market Structure Real-World Example

Many Identical Perfect Competition (Ch. Rose market
(Homogeneous) 9)
Many Differentiated Monopolistic Competition Local physicians,
(Heterogeneous) restaurants
Few Identical Homogeneous Oligopoly US salt market
(Homogeneous)
Few Differentiated Differentiated Oligopoly US cola market (Coke vs
(Heterogeneous) Pepsi)
One Dominant Any Dominant Firm Market German fixed-line
telephone (Deutsche
Telekom)
One Any Monopoly (Ch. 11) Internet domain name
registration

2. Imperfect Competition: The Core of Chapter 13

⭐ KEY CONCEPT: Imperfect Competition

Chapter 13 focuses on IMPERFECT COMPETITION — a middle ground between perfect

competition and monopoly.

• Unlike MONOPOLY: firms DO have competitors

• Unlike PERFECT COMPETITION: firms face DOWNWARD-SLOPING demand (they are NOT
price takers)

Two main forms of imperfect competition:

1. OLIGOPOLY — Few firms (due to entry barriers)
2. MONOPOLISTIC COMPETITION — Many firms with differentiated products

3. Oligopoly: Core Characteristics

OLIGOPOLY A market structure with a FEW sellers (due to entry barriers), where each
firm can influence market price either indirectly (via production) or directly
 (via pricing).

Key features of oligopoly:

• Individual firms are PRICE-SETTERS (not price takers)
• Profit maximization requires accounting for: own costs AND rivals' behavior
• COMPETITIVE INTERDEPENDENCE: one firm's decision significantly affects rivals'
profits
• Different strategic models depending on what firms compete on and when

3.1 Two Dimensions of Strategic Interaction

WHAT firms compete on: WHEN firms decide:

• QUANTITY competition → Cournot / • SIMULTANEOUS decisions → Cournot,
Stackelberg models Bertrand
• PRICE competition → Bertrand model • SEQUENTIAL decisions → Stackelberg
(Cournot-Stackelberg)

📊 Oligopoly Model Classification Matrix

| NO prior knowledge | YES (sequential)

| (Simultaneous) |
---------------------+-----------------------+---------------------------
QUANTITY competition | Cournot Model (2.1) | Cournot-Stackelberg (2.3)
PRICE competition | Bertrand Model (2.2) | (not covered)

→ The type of model depends on WHAT firms compete on and WHEN they decide.

🔁 SECTION I — QUICK REVISION SUMMARY

✔ Markets differ by: (1) number of firms and (2) product differentiation
✔ Homogeneous = identical products | Heterogeneous = differentiated products
✔ Imperfect competition = firms have rivals BUT face downward-sloping demand
✔ Two types: Oligopoly (few firms) vs. Monopolistic Competition (many + differentiated)
✔ Oligopolists face competitive interdependence — rivals' decisions affect own profit
✔ Three oligopoly models: Cournot (qty, simultaneous), Bertrand (price, simultaneous),
Stackelberg (qty, sequential)
II. OLIGOPOLY WITH HOMOGENEOUS PRODUCTS
This section covers three models of oligopoly where all firms sell identical products. Real-world
examples include the glass container industry, titanium dioxide, salt, computer chips, and air routes
between two cities.

1. The Cournot Model (Quantity Competition, Simultaneous)

Each firm simultaneously and independently chooses a quantity to
COURNOT
produce. Total output of all firms determines the market price. Each firm
MODEL
takes rivals' quantities as given.

1.1 Core Assumptions

• Firms decide on QUANTITY (not price)
• Decisions are made SIMULTANEOUSLY
• Decisions are made NON-COOPERATIVELY (no collusion)
• Each firm has NO knowledge of rivals' plans before deciding
• Market price is determined by TOTAL output: higher total output → lower price

1.2 Cournot Equilibrium (Nash Equilibrium in Quantities)

Each firm chooses a profit-maximizing output given the EXPECTED
COURNOT
output of rivals. Every firm's output is a BEST RESPONSE to every other
EQUILIBRIUM
firm's output. No firm wants to deviate unilaterally.

Why does equilibrium arise?

• Total output Q = q₁ + q₂ + … determines market price P
• Market price P determines each firm's revenue and profit
• Each firm maximizes profit by finding its best response to rivals' choices
• Where ALL best responses are simultaneously satisfied → Cournot Equilibrium

1.3 Best-Response (Reaction) Functions

📐 Reaction Function (Best-Response Function)

For a duopoly (2 firms), each firm has a reaction function showing the
profit-maximizing quantity as a function of the rival's output:

q₁* = f(q₂) → Firm 1's best response given Firm 2's output
q₂* = g(q₁) → Firm 2's best response given Firm 1's output

KEY PROPERTY: In Cournot, reaction functions SLOPE DOWNWARD.

If rival produces more → you reduce your own output (to avoid price collapse).
 Cournot Equilibrium: the point where BOTH reaction functions intersect.

1.4 Numerical Example — Standard Duopoly

Setup (as implied by the slide data):
• Market demand: P = 100 − Q, where Q = q₁ + q₂
• Marginal Cost for both firms: MC = 10 (constant, equal)

Step 1 — Firm 1's profit maximization:

π₁ = (P − MC) × q₁ = (100 − q₁ − q₂ − 10) × q₁ = (90 − q₁ − q₂) × q₁
Maximize: dπ₁/dq₁ = 90 − 2q₁ − q₂ = 0
⟹ Reaction function: q₁ = (90 − q₂) / 2 = 45 − q₂/2

Step 2 — By symmetry, Firm 2's reaction function:

q₂ = 45 − q₁/2

Step 3 — Solve simultaneously (substitute q₂ into q₁'s reaction function):

q₁ = 45 − (45 − q₁/2)/2 = 45 − 22.5 + q₁/4
3q₁/4 = 22.5 → q₁ = 30, q₂ = 30

Step 4 — Market outcomes:

• Total output: Q = 30 + 30 = 60
• Market price: P = 100 − 60 = 40
• Profit per firm: π = (40 − 10) × 30 = 900
• Total industry profit: 2 × 900 = 1,800

1.5 How Do Firms Reach Cournot Equilibrium? (Iterative Reasoning)

💡 Step-by-Step Iterated Best Response (from slides)

(1) SK will NEVER produce more than 45 → monopoly outcome (upper bound)
(2) Given (1), Samsung will produce AT LEAST 22.5
(3) Given (2), SK will produce NO MORE THAN 33.75
(4) Given (3), Samsung will produce AT LEAST 28.125
… and so on, converging step by step …
(∞) Both converge to producing 30 units = Cournot Equilibrium

This is called 'iterated dominance' reasoning — a foundation for Nash Equilibrium.

1.6 Comparison: Cartel vs. Cournot vs. Perfect Competition

Market Outcome Price (P) Total Quantity (Q) Total Industry
 Profit
Cartel (Monopoly) $55 45 units $2,025
Cournot Oligopoly $40 60 units $1,800
Perfect Competition $10 = MC 90 units $0

Interpretation:
• Cournot output EXCEEDS monopoly but is LESS than perfect competition
• Cournot price is BELOW monopoly price but ABOVE competitive price
• Cournot profit is POSITIVE but LESS than cartel profit
• As number of Cournot firms → ∞, outcome approaches perfect competition

1.7 Cooperation vs. Self-Interest Tension in Oligopoly

⚠️The Oligopoly Dilemma (Key Exam Point)

• If firms COOPERATE (form a cartel): they act as one monopolist

→ Produce monopoly quantity (small), charge monopoly price (high), maximize JOINT profit

• However, given the small output of other firms, EACH individual firm
has an incentive to INCREASE its own output (profitable deviation)

• Strategy: 'Make a collusive agreement, then CHEAT on it' = most profitable individual strategy

• This explains why FEW cartels are stable — self-interest destroys cooperation
• Anti-trust laws make cartels ILLEGAL in most jurisdictions (cfr. Chapter 14)

1.8 Public Policy on Oligopoly Cooperation

• Cooperation among oligopolists → SOCIALLY UNDESIRABLE: too little output, high prices
• ANTITRUST LAWS make it illegal to reduce competition or monopolize markets
• International cartels (e.g., OPEC) are harder to enforce
• Cheating threatens cartel stability even when laws are weak

1.9 General Cournot Result: N Firms

📐 Cournot with N Symmetric Firms

With N firms and market demand P = a − bQ, each with MC = c:

Each firm's output: q* = (a − c) / [b(N + 1)]

Total output: Q* = N(a − c) / [b(N + 1)]
Market price: P* = a − bQ* = [a + Nc] / (N + 1)

KEY INSIGHTS:
 → As N → 1: approaches MONOPOLY outcome
→ As N → ∞: approaches PERFECT COMPETITION (P → MC)
→ More firms = lower price, higher total output, lower per-firm profit

🔁 COURNOT MODEL — QUICK REVISION SUMMARY

✔ Quantity competition, simultaneous, non-cooperative

✔ Each firm maximizes profit by choosing best-response quantity to rivals
✔ Reaction functions SLOPE DOWNWARD (strategic substitutes)
✔ Equilibrium: intersection of all reaction functions (Nash Equilibrium)
✔ Price > MC → positive profits (but less than cartel)
✔ Output between monopoly and perfect competition
✔ Tension: cooperate as cartel vs. cheat for individual gain

2. The Bertrand Model (Price Competition, Simultaneous)

Each firm simultaneously and independently chooses a PRICE (not a
BERTRAND
quantity). Each firm can meet all demand for its product at the price it
MODEL
sets.

2.1 Core Assumptions

• Firms decide on PRICE (not quantity)
• Decisions are made SIMULTANEOUSLY
• Decisions are made NON-COOPERATIVELY
• Products are HOMOGENEOUS (identical) — consumers always buy from cheapest firm
• Each firm can supply the ENTIRE market demand

2.2 Demand Structure in Bertrand (Homogeneous Goods)

📊 Individual Firm Demand in Bertrand Oligopoly

Given identical products and two firms (1 and 2):

• If Firm 1 sets price p₁ < p₂: Firm 1 captures ALL market demand
• If Firm 1 sets price p₁ > p₂: Firm 1 sells NOTHING
• If Firm 1 sets price p₁ = p₂: Both firms SHARE the market equally

This 'winner-take-all' structure creates fierce price competition.

→ A small price cut below rivals = capture entire market
→ This leads to a very specific equilibrium...
2.3 Bertrand Equilibrium — The 'Paradox'

⭐ BERTRAND EQUILIBRIUM (KEY RESULT)

EQUILIBRIUM: Both firms set price = Marginal Cost (P* = MC)

WHY? Proof by elimination:

• If p > MC: rival undercuts by ε → captures all sales → original firm gets nothing
→ Both firms keep undercutting until p = MC
• If p = MC: no incentive to deviate (cutting price = losses, raising = lose all sales)

RESULT: Even with only 2 firms, Bertrand produces the COMPETITIVE OUTCOME:
→ Price = MC → Zero economic profit

This is called the 'Bertrand Paradox': duopoly produces same result as perfect competition!

2.4 Bertrand Reaction Functions

Unlike Cournot, Bertrand reaction functions SLOPE UPWARD:
• If rival sets a HIGH price → you also set a somewhat higher price (follow upward)
• If rival cuts price → you must also cut price to remain competitive
• 'More competitive price by rival → more aggressive response by you'
Strategic terminology: in Bertrand, prices are STRATEGIC COMPLEMENTS (upward-sloping best
responses).

2.5 Cournot vs. Bertrand: A Critical Comparison

Feature Cournot Model Bertrand Model
Decision variable Quantity (q) Price (p)
Timing Simultaneous Simultaneous
Products Homogeneous Homogeneous
Reaction functions DOWNWARD sloping UPWARD sloping
Strategic relationship Strategic substitutes Strategic complements
Equilibrium price P > MC (above marginal cost) P = MC (competitive)
Equilibrium profits Positive Zero
Time frame Long-run (capacity decisions) Short-run (price competition)
Firm's expectation Rival keeps quantity fixed Rival keeps price fixed

2.6 When is Each Model Relevant?

COURNOT — Long-run Model BERTRAND — Short-run Model

 • Firms compete on capacity/production • Short-run price competition (capacity already
volumes set)
• Rivals expected to KEEP QUANTITY FIXED • Rivals expected to KEEP PRICE FIXED;
regardless of price changes small cuts steal customers
• Appropriate when building capacity is the key • Appropriate when adjusting price is fast and
strategic decision costless
• Example: airlines allocating seats on a route • Example: gas stations on the same street

🔁 BERTRAND MODEL — QUICK REVISION SUMMARY

✔ Price competition, simultaneous, non-cooperative

✔ Homogeneous goods → lowest-price firm captures entire market
✔ Equilibrium: P = MC → ZERO profit (even with only 2 firms!)
✔ 'Bertrand Paradox': duopoly = perfect competition outcome
✔ Reaction functions slope UPWARD (strategic complements)
✔ Cournot: rival keeps qty fixed | Bertrand: rival keeps price fixed

3. The Stackelberg Model (Quantity Competition, Sequential)

A sequential quantity competition duopoly. The LEADER chooses
STACKELBERG
quantity first, then the FOLLOWER observes this and chooses optimally.
MODEL
Leader anticipates follower's reaction when making its decision.

3.1 Core Assumptions

• Firms decide on QUANTITY (like Cournot)
• Decisions are SEQUENTIAL — leader moves first, follower reacts
• Leader knows the follower's reaction function (rational anticipation)
• Leader commits CREDIBLY to its output level
• Example: General Electric in the turbine generator industry

3.2 How to Solve Stackelberg

Use BACKWARD INDUCTION:
1. Solve FOLLOWER's problem first: derive follower's reaction function q₂*(q₁)
2. LEADER anticipates this: substitutes q₂*(q₁) into its own profit function
3. Leader maximizes its own profit with respect to q₁, taking q₂*(q₁) as given
4. Compute follower's optimal quantity using q₂*(q₁*)

3.3 Numerical Example (Using Same Demand as Cournot)

Setup: P = 100 − Q, MC = 10 for both firms. Firm 1 = Leader, Firm 2 = Follower.
Follower's reaction function (same as Cournot): q₂ = 45 − q₁/2

Leader's profit (substituting follower's reaction):

π₁ = (100 − q₁ − q₂ − 10) × q₁ = (90 − q₁ − (45 − q₁/2)) × q₁
π₁ = (45 − q₁/2) × q₁ = 45q₁ − q₁²/2
dπ₁/dq₁ = 45 − q₁ = 0 → q₁* = 45 (Leader's output)

Follower's output: q₂ = 45 − 45/2 = 22.5

Market outcomes:
• Total output: Q = 45 + 22.5 = 67.5
• Market price: P = 100 − 67.5 = 32.5
• Leader profit: π₁ = (32.5 − 10) × 45 = 1,012.5
• Follower profit: π₂ = (32.5 − 10) × 22.5 = 506.25
• Total profit: 1,518.75 (less than Cournot's 1,800)

3.4 First-Mover Advantage

⭐ FIRST-MOVER ADVANTAGE (Key Exam Concept)

The Stackelberg outcome is ASYMMETRIC because of first-mover advantage:

Compared to Cournot equilibrium (both producing 30):

→ LEADER produces MORE (45 > 30) and earns HIGHER profit (1,012.5 > 900)
→ FOLLOWER produces LESS (22.5 < 30) and earns LOWER profit (506.25 < 900)
→ Market PRICE is LOWER (32.5 < 40)
→ Total output is HIGHER (67.5 > 60)

Why? The leader strategically commits to HIGH output → follower is forced to cut back
→ The follower's reaction function 'works against' the follower

3.5 The Commitment Problem in Stackelberg

⚠️Credibility and Commitment Problem

Leader-follower models suffer from 'commitment' problems:

• After the follower has decided, the LEADER would BENEFIT from changing its
own decision (e.g., reduce output now that follower has committed)
→ This creates a STABILITY PROBLEM

• The FOLLOWER may not believe the leader will maintain its high output
→ Follower might increase production if leader's commitment is not credible
 KEY: First-mover advantage only holds if the leader's output choice is CREDIBLE
→ How credibility is achieved is explored in Chapter 14 (strategic commitment)

3.6 Complete Model Comparison: Cournot vs. Stackelberg vs. Cartel vs. Competition
Model Firm 1 Output Firm 2 Output Total Q Price Total
Profit
Cartel (Monopoly) 22.5 22.5 45 $55 $2,025
Cournot 30 30 60 $40 $1,800
Stackelberg 45 (leader) 22.5 (follower) 67.5 $32.5 $1,518.7
5
Perfect Competition — — 90 $10 $0

🔁 STACKELBERG MODEL — QUICK REVISION SUMMARY

✔ Sequential quantity competition: leader chooses first, follower reacts

✔ Solved by backward induction: follower's reaction → leader's optimization
✔ FIRST-MOVER ADVANTAGE: leader produces MORE, earns MORE
✔ Follower produces LESS than Cournot, earns LESS
✔ Market price LOWER than Cournot, total output HIGHER
✔ Requires CREDIBLE COMMITMENT by leader (otherwise follower ignores it)

III. DOMINANT FIRM MARKETS

1. Market Structure: Dominant Firm + Competitive Fringe

A market with ONE large dominant firm (high market share) and a
DOMINANT FIRM
'competitive fringe' of many smaller firms. The fringe behaves like perfect
MARKET
competitors (price takers). The dominant firm acts as a partial monopolist.

1.1 Behavior of Each Group

COMPETITIVE FRINGE DOMINANT FIRM

• Many small firms • One large firm
• Take market price as GIVEN • Sets quantity strategically
• Behave like perfect competitors • Faces 'RESIDUAL DEMAND'
• Supply curve: upward-sloping • Residual = Market demand − Fringe supply
• Example: small regional steel mills • Acts as monopolist on residual demand
1.2 Residual Demand — The Key Concept
The demand curve faced by the dominant firm, calculated by subtracting
RESIDUAL
the competitive fringe's supply from total market demand at each price:
DEMAND
D_residual(P) = D_market(P) − S_fringe(P)

📐 How the Dominant Firm Behaves

1. The dominant firm faces the RESIDUAL DEMAND curve (market demand minus fringe supply)
2. It maximizes profit on this residual demand, just like a monopolist:
→ Set MR_residual = MC_dominant
3. The market price is determined by the dominant firm's choice
4. The competitive fringe then supplies optimally at that price (MR = P = MC_fringe)

1.3 Effect of Growing Fringe

• If fringe supply RISES (e.g., new entrants, lower costs): residual demand FALLS
• Dominant firm must lower price → output of dominant firm decreases
• Fringe captures more market share → dominant firm loses dominance
• This shows market power can erode over time with competitive pressure

1.4 Real-World Examples of Dominant Firm Markets

Dominant Firm Industry
US Steel Corporation US steel industry
Alcoa Aluminum industry
Deutsche Telekom AG German telephone market (fixed-line)
De Beers Global diamond industry

1.5 Position in the Market Structure Spectrum

📍 Dominant Firm as an Intermediate Market Structure

Dominant firm markets sit BETWEEN:

← Monopoly (one firm, no fringe) ←→ Standard oligopoly (similar-sized firms) →

• More competitive than pure monopoly (fringe constrains dominant firm's price)
• Less competitive than standard oligopoly (dominant firm still has significant power)
• As fringe grows → structure approaches perfect competition

🔁 DOMINANT FIRM — QUICK REVISION SUMMARY

 ✔ One dominant firm + many small fringe firms
✔ Fringe firms = price takers (behave like perfect competitors)
✔ Dominant firm faces RESIDUAL DEMAND = Market demand − Fringe supply
✔ Dominant firm maximizes profit on residual demand (like monopolist)
✔ Growing fringe → declining residual demand → falling price & dominance
✔ Examples: US Steel, Alcoa, Deutsche Telekom, De Beers

IV. OLIGOPOLY WITH HORIZONTALLY DIFFERENTIATED

PRODUCTS

1. Product Differentiation — Definitions

PRODUCT Products are differentiated when consumers consider them to be LESS
DIFFERENTIATIO THAN PERFECT SUBSTITUTES. Firms sell distinctive products rather
N than identical goods.

1.1 Two Types of Product Differentiation

HORIZONTAL Differentiation VERTICAL Differentiation

• Products differ in characteristics/attributes • One product is UNAMBIGUOUSLY better
• Some consumers prefer Product A, others than another
prefer B • All consumers prefer the superior product (if
• Neither is objectively 'better' — just different same price)
• Example: Coca-Cola vs Pepsi, red car vs blue • Example: higher quality vs lower quality
car phone
• Relevant for this chapter • Not the focus of this chapter

1.2 Real-World Examples of Horizontal Differentiation

• Battery market (Duracell vs Energizer)
• Soft drinks market (Coca-Cola vs Pepsi)
• Automobile market (different brands with different styles)
• Cola example in detail (Section 2.2 below)

2. Bertrand Competition with Horizontally Differentiated Products

2.1 How Differentiation Changes the Analysis

⭐ KEY CHANGE: Differentiation Breaks the Bertrand Paradox

 In homogeneous Bertrand: undercutting rival by 1 cent → capture ENTIRE market
→ Led to P = MC (zero profit) paradox

With DIFFERENTIATION: undercutting rival by 1 cent does NOT capture entire market
→ Some consumers STILL prefer the rival's brand even at a slightly higher price
→ Firm faces a DOWNWARD-SLOPING demand curve (not perfectly elastic)
→ Setting price below rival → gain SOME customers, not all
→ Setting price above rival → lose SOME customers, not all

RESULT: Firms have MARKET POWER → prices above MC → POSITIVE profits!

2.2 Demand Functions with Differentiation — Coke & Pepsi Example

From the slides, differentiated demand functions might look like:

📐 Differentiated Demand — Coke & Pepsi

Demand for Coke: Qc = f(Pc, Pp) — decreasing in own price Pc, increasing in Pepsi price Pp
Demand for Pepsi: Qp = g(Pc, Pp) — decreasing in own price Pp, increasing in Coke price Pc

Key Properties:
• Own-price effect: higher own price → lower demand for own product (standard)
• Cross-price effect: higher rival price → higher demand for own product
(because some consumers switch to your brand when rivals charge more)

Typical textbook example (Besanko & Braeutigam):

Qc = 63.42 − 3.98Pc + 2.25Pp
Qp = 49.52 − 5.48Pp + 1.40Pc

2.3 Reaction Functions in Differentiated Bertrand

📐 Reaction Functions — Differentiated Bertrand

Each firm maximizes profit: π = (P − MC) × Q(P, P_rival)

Setting dπ/dP = 0 gives firm's BEST-RESPONSE price function:

Pc* = f(Pp) — Coke's optimal price depends on Pepsi's price
Pp* = g(Pc) — Pepsi's optimal price depends on Coke's price

CRITICAL: These reaction functions SLOPE UPWARD:

→ If Pepsi raises its price → Coke can also raise its price (demand won't fall as much)
→ Prices are STRATEGIC COMPLEMENTS (as in homogeneous Bertrand)

Equilibrium: intersection of both reaction functions → both firms choose

best response simultaneously
2.4 Equilibrium Interpretation
• Equilibrium: all firms simultaneously choose best response to each other
• Graphically: point where both reaction functions INTERSECT
• Prices need NOT be equal in equilibrium (if firms differ in costs or demand elasticity)
• Both prices are ABOVE marginal cost → POSITIVE profits for both firms
• Example: Pepsi may have lower marginal cost OR more elastic demand → different equilibrium
price

2.5 Effect of Differentiation Strength on Competition

STRONG Differentiation WEAK Differentiation

• Demand is much less sensitive to rival's price • Demand is very sensitive to rival's price
• Firm can charge high price with little market • Must stay close to rival's price
loss • Lower market power → lower profits
• Higher market power → higher profits • Approaches homogeneous Bertrand as limit
• Example: luxury vs economy brand

3. Summary: Oligopolistic Markets — Conclusion

📍 Factors Determining Oligopoly Analysis

The economic analysis of oligopoly depends on HOW firms interact strategically:

1. COOPERATION vs. NON-COOPERATION: do firms collude or compete?

2. QUANTITY vs. PRICE: what is the strategic variable?
3. SIMULTANEOUS vs. SEQUENTIAL: who moves when?
4. HOMOGENEOUS vs. HETEROGENEOUS: are products identical or differentiated?

COMPARISON WITH OTHER MARKET STRUCTURES:

← Monopoly: no rivals → no strategic interaction needed
← Oligopoly: rivals exist → strategic interaction is ESSENTIAL
← Perfect competition: each firm too small to affect rivals → no interaction

🔁 DIFFERENTIATED OLIGOPOLY — QUICK REVISION SUMMARY

✔ Horizontal differentiation = consumers prefer different product attributes

✔ Differentiation → downward-sloping demand → market power → positive profit
✔ No longer 'all-or-nothing' demand — undercutting gains SOME but not ALL customers
✔ Reaction functions slope UPWARD (prices are strategic complements)
✔ Equilibrium: both prices above MC → positive profits
✔ Stronger differentiation → less price sensitivity → more market power
V. MONOPOLISTIC COMPETITION

1. Definition and Core Features

A market with MANY sellers and HORIZONTALLY DIFFERENTIATED
MONOPOLISTIC products. Firms have monopoly-like demand curves (downward-sloping)
COMPETITION but face perfectly competitive entry conditions (free entry → zero long-run
profit).

1.1 Mixed Features: Monopoly + Perfect Competition

Features from MONOPOLY: Features from PERFECT COMPETITION:

• Downward-sloping demand curve • MANY sellers (no strategic interdependence)
• Firm has market power (price setter) • FREE ENTRY (no barriers)
• P > MC in equilibrium • Zero profit in the LONG RUN
• Positive short-run profits possible • No single firm can dominate

1.2 Real-World Examples

• Local retail markets (coffee shops, bookstores, clothing stores)
• Consumer products (shampoos, soaps, cereals)
• Bars and restaurants (each has a unique menu, atmosphere, location)
• Local physicians (differentiated by specialty, location, reputation)

2. Short-Run Equilibrium
📊 Short-Run Equilibrium: Positive Profits

In the SHORT RUN, a monopolistically competitive firm behaves like a monopolist:

• Faces its own downward-sloping demand curve

• Maximizes profit where MR = MC
• Sets price on demand curve above the MR = MC quantity

KEY RESULT:
→ Price EXCEEDS Average Cost (P > AC)
→ Firm earns POSITIVE economic profits

This is temporary! Positive profits attract new entrants...

3. Long-Run Equilibrium
⭐ Long-Run Equilibrium: Zero Profits (Critical Exam Topic)

FREE ENTRY drives out economic profits in the long run:

MECHANISM:
1. Short-run profits attract NEW ENTRANTS
2. New firms offer substitute products → DEMAND for each existing firm DECREASES
(demand curve shifts LEFT and becomes more elastic)
3. Entry continues UNTIL profits are driven to ZERO

ZERO-PROFIT CONDITION:
→ Demand curve is tangent to the Average Cost curve
→ At equilibrium quantity: P = AC (price equals average cost)
→ Economic profit = 0

KEY: 'Tangent' means demand curve just touches AC curve — does not cross it

3.1 Long-Run Equilibrium Characteristics

• Price > Marginal Cost (firm still has market power from differentiation)
• Price = Average Cost (zero economic profit from free entry)
• Firm operates with EXCESS CAPACITY — not producing at minimum AC
• Resources are used less efficiently than under perfect competition
• Output is LESS than the quantity that minimizes AC ('excess capacity theorem')

3.2 More vs. Less Elastic Demand in Long Run

MORE ELASTIC Demand: LESS ELASTIC Demand:

• Products are closer substitutes • Products are more differentiated
• Demand is more sensitive to price • Demand is less sensitive to price
• Tangency point closer to minimum AC • Tangency point farther from minimum AC
• Less excess capacity • More excess capacity
• Price closer to MC • Price farther above MC

3.3 Important Note: Entry Does NOT Always Lower Prices

⚠️Counterintuitive Result: Entry Can RAISE Prices

The slides give an important counterexample:

Scenario: New entry occurs ALONGSIDE COST REDUCTIONS

→ Even though more firms enter (usually → lower prices),
cost reductions can SHIFT equilibrium prices upward
 Example from slides: Equilibrium price RISES from $50 to $55 after entry

LESSON: Free entry does not automatically guarantee lower prices.

The net effect depends on both the entry effect AND the cost change.
Always analyze the full equilibrium, not just one channel.

4. Important Remarks on Monopolistic Competition

📌 Key Remarks (directly from slides)

Remark 1: In long-run equilibrium, firm charges MORE than marginal cost

→ Unlike perfect competition where P = MC
→ This represents a form of market inefficiency (deadweight loss exists)

Remark 2: The tangency condition ensures ZERO PROFIT (P = AC), not P = MC

→ The firm is on the downward-sloping part of its demand curve
→ And on the downward-sloping part of its AC curve (left of minimum AC)

Remark 3: More elastic demand → tangency closer to efficient scale (less excess capacity)
Less elastic demand → more excess capacity (farther from minimum AC)

5. Final Remark: Market Structure Synthesis

⭐ CRITICAL SYNTHESIS (Exam Focus)

Market structures are determined by:

1. Number of sellers and entry conditions
2. Degree of product differentiation

IMPORTANT INSIGHT: Neither differentiation alone NOR few competitors alone

guarantees POSITIVE profit. Examples where profit = 0 despite apparent power:

• MONOPOLISTIC COMPETITION: many firms + differentiated products → ZERO LONG-RUN

PROFIT
(free entry drives profits to zero even with differentiation)

• BERTRAND HOMOGENEOUS OLIGOPOLY: few firms + identical products → ZERO PROFIT

(fierce price competition drives price to MC even with few rivals)

→ POSITIVE PROFIT requires BOTH barriers to entry AND market power (from qty competition
or product differentiation that shields from Bertrand-like competition)
 🔁 MONOPOLISTIC COMPETITION — QUICK REVISION SUMMARY

✔ Many sellers + horizontally differentiated products

✔ Features of MONOPOLY: downward-sloping demand, P > MC
✔ Features of PERFECT COMPETITION: many sellers, free entry, zero LR profit
✔ SHORT RUN: P > AC → positive economic profit
✔ LONG RUN: free entry → demand shifts left → P = AC (tangency condition) → zero profit
✔ Long-run: P > MC but P = AC → excess capacity
✔ Entry does NOT always lower prices (if entry is accompanied by cost changes)
✔ Examples: local restaurants, bars, consumer products, physicians

PART II — CONDENSED REVISION SHEET

QUICK REFERENCE: Chapter 13 — Market Structure &

Competition

I. Market Structures Overview

Structure # Firms Products Entry Long-Run Price vs. MC
Profit
Perfect Competition Many Identical Free Zero P = MC
Monopolistic Many Differentiate Free Zero P > MC
Competition d
Oligopoly (Cournot) Few Identical Barriers Positive P > MC
Oligopoly (Bertrand Few Identical Barriers ZERO P = MC
Hom.)
Bertrand Few Differentiate Barriers Positive P > MC
Differentiated d
Dominant Firm 1 dom. + Any Partial Positive P > MC
fringe
Monopoly One Any Blocked Positive P > MC

Memory Trigger: 'PMOCBDM' → Perfect, Monopolistic, Oligopoly-Cournot, oligopoly-Bertrand,

Dominant, Monopoly

II. Cournot Model — Flash Cards

COURNOT KEY FACTS
 Variable: Quantity (q)
Timing: Simultaneous
Products: Homogeneous
Reaction fn: DOWNWARD sloping
Strategic rel.: Strategic substitutes
Equilibrium P: Between monopoly and competitive price (P > MC)
Profits: POSITIVE
Framework: P = a − bQ | MR = MC for each firm | Solve simultaneous reaction fns

Memory Trigger: 'Cournot = Quantities Compete Calmly (QCC) → reaction goes DOWN'

III. Bertrand Model — Flash Cards

BERTRAND KEY FACTS

Variable: Price (p)

Timing: Simultaneous
Products: Homogeneous (standard) OR Differentiated (extended)
Reaction fn: UPWARD sloping
Strategic rel.: Strategic complements
Homogeneous eq: P = MC → ZERO profit ('Bertrand Paradox')
Differentiated: P > MC → POSITIVE profit (differentiation breaks the paradox)

Memory Trigger: 'Bertrand = Brutal Price Battle → goes to Bottom (P=MC) unless differentiated'

IV. Stackelberg Model — Flash Cards

STACKELBERG KEY FACTS

Variable: Quantity (q)

Timing: SEQUENTIAL (leader → follower)
Solution method: Backward induction
Leader: Produces MORE than Cournot → earns MORE profit
Follower: Produces LESS than Cournot → earns LESS profit
Market price: LOWER than Cournot (more total output)
Key concept: FIRST-MOVER ADVANTAGE
Key problem: COMMITMENT problem (must be credible)

Memory Trigger: 'Stackelberg = Leader Strikes First → gets Bigger Slice'

V. Dominant Firm — Flash Cards
DOMINANT FIRM KEY FACTS

Structure: 1 dominant firm + competitive fringe (many small price-takers)

Key concept: RESIDUAL DEMAND = Market demand − Fringe supply
Dominant firm: Maximizes profit on residual demand (acts as monopolist)
Fringe: Takes market price as given, supplies optimally
If fringe grows: Residual demand falls → dominant firm loses market power
Examples: US Steel, Alcoa, Deutsche Telekom, De Beers

Memory Trigger: 'Dominant Firm = King minus what fringe already took'

VI. Monopolistic Competition — Flash Cards

MONOPOLISTIC COMPETITION KEY FACTS

Structure: Many firms + differentiated products

SHORT RUN: P > AC → positive economic profit (acts like monopolist)
LONG RUN: Free entry → demand shifts left → tangency of demand & AC → P = AC
Long-run: P > MC (market power) BUT P = AC (zero profit)
Excess capacity: Firms produce below minimum AC scale
Examples: Restaurants, bars, local doctors, consumer products
Key warning: Entry ≠ always lower prices (counterexample in slides: $50 → $55)

Memory Trigger: 'Mono-Comp = Short-run winner, Long-run zero — entry kills the profit'

VII. Key Formulas & Decision Rules

Concept Formula / Rule
Cournot reaction fn (symmetric, P=a−bQ, MC=c) q* = (a−c) / [b(N+1)]
Cournot 2-firm (P=100−Q, MC=10) q₁=q₂=30, Q=60, P=40
Stackelberg leader output (same setup) q₁=45, q₂=22.5, Q=67.5, P=32.5
Bertrand homogeneous equilibrium P = MC → zero profit
Monopolistic comp. LR condition P = AC (tangency); P > MC
Residual demand (dominant firm) D_res(P) = D_mkt(P) − S_fringe(P)
Cooperative (cartel) outcome (P=100−Q, MC=10) Q=45, P=55, π=2025

PART III — EXAM PREDICTOR

PREDICTED EXAM QUESTIONS WITH MODEL ANSWERS

CATEGORY 1: SHORT DEFINITION QUESTIONS

Q1. Define 'Competitive Interdependence' and explain its significance in oligopoly.

MODEL ANSWER:
Competitive interdependence refers to the situation in oligopoly markets where the
decisions of one firm significantly affect the profits of rival firms, and vice versa.
Unlike perfect competition (where individual firms are too small to affect rivals) or
monopoly (where there are no rivals), oligopolists must account for rivals' responses
when making pricing or production decisions.

Significance: It creates the need for STRATEGIC MODELS of firm behavior.

Different assumptions about what firms compete on (price vs. quantity) and the
timing of decisions (simultaneous vs. sequential) lead to very different outcomes.

KEY POINTS FOR FULL MARKS:

• Few firms → individual decisions matter to rivals
• Must anticipate rival reactions
• Leads to different strategic models

COMMON MISTAKE: Confusing competitive interdependence with collusion.

They are distinct — interdependence can occur even in purely non-cooperative settings.

Q2. Define 'Residual Demand' and explain how it applies to dominant firm
markets.

MODEL ANSWER:
Residual demand is the demand faced by the dominant firm after subtracting the
supply of the competitive fringe from total market demand at each price level:
D_residual(P) = D_market(P) − S_fringe(P)

In a dominant firm market, the fringe firms are price takers — they supply
optimally at the prevailing market price. The dominant firm then maximizes
profit on its residual demand, behaving like a monopolist on this smaller demand.

KEY POINTS FOR FULL MARKS:

• Correct formula: D_res = D_mkt − S_fringe
• Dominant firm = monopolist on residual demand
• Fringe = price takers
• If fringe grows, residual demand shrinks

COMMON MISTAKE: Saying the dominant firm competes directly with fringe.
In reality, the dominant firm INCORPORATES fringe behavior into its demand calculation.

Q3. What is the 'Bertrand Paradox'?

MODEL ANSWER:
The Bertrand Paradox refers to the surprising result that in a duopoly (only 2 firms)
competing in prices with HOMOGENEOUS products, the equilibrium outcome is the
same as under PERFECT COMPETITION: price equals marginal cost and economic
profit is zero.

This is 'paradoxical' because one might expect 2 firms to retain some market power,
but fierce price undercutting drives prices all the way down to MC.

KEY POINTS FOR FULL MARKS:

• Duopoly = competitive outcome (P = MC, zero profit)
• Reason: homogeneous goods → winner-take-all price competition
• Contrast with Cournot where duopoly yields positive profit

COMMON MISTAKE: Forgetting that this paradox DISAPPEARS with product differentiation
or capacity constraints — both allow prices above MC even with few firms.

CATEGORY 2: CONCEPT EXPLANATION QUESTIONS

Q4. Explain the Cournot model step by step, including how equilibrium is reached.

MODEL ANSWER:
The Cournot model describes quantity competition among oligopolists:

SETUP:
• Each firm simultaneously chooses a quantity to produce
• No cooperation, no knowledge of rivals' choices
• Total output Q = Σqᵢ determines market price via demand curve

EQUILIBRIUM DERIVATION (2 firms, P = a−bQ, MC = c):

1. Firm 1 maximizes: π₁ = (a − b(q₁+q₂) − c) × q₁
2. FOC: a − 2bq₁ − bq₂ − c = 0 → Reaction fn: q₁ = (a−c)/(2b) − q₂/2
3. By symmetry: q₂ = (a−c)/(2b) − q₁/2
4. Solve simultaneously: q₁* = q₂* = (a−c)/(3b)

KEY PROPERTIES:
• Reaction functions slope DOWNWARD
• Price is ABOVE MC (positive profit)
• Output between monopoly and competitive levels

KEY POINTS FOR FULL MARKS: correct math setup, reaction functions, Nash condition,
comparison with monopoly/competition.

COMMON MISTAKE: Not checking the Nash condition — both firms must be best-responding.

Q5. Explain short-run vs. long-run equilibrium in monopolistic competition.

MODEL ANSWER:
SHORT RUN:
• The firm faces a downward-sloping demand curve (product differentiation)
• Acts like a monopolist: sets MR = MC
• Price exceeds average cost: P > AC
• Earns positive economic profit

TRANSITION MECHANISM:
• Positive profits attract new entrants offering substitute products
• Demand for each existing firm DECREASES (shifts left, becomes more elastic)
• Entry continues while profit > 0

LONG RUN:
• Demand curve is tangent to the average cost curve
• Price = Average Cost → zero economic profit
• Price STILL exceeds Marginal Cost (P > MC) — market power remains
• Firm operates with EXCESS CAPACITY (to the left of minimum AC)

KEY POINTS FOR FULL MARKS: short-run π > 0; entry mechanism; LR tangency; P = AC but P
> MC.

COMMON MISTAKE: Saying P = MC in long-run monopolistic competition. WRONG.

P = AC (zero profit condition) but P > MC (market power still exists).

CATEGORY 3: COMPARISON QUESTIONS

Q6. Compare and contrast the Cournot and Bertrand models of homogeneous
oligopoly.

MODEL ANSWER:

SIMILARITIES:
• Both: few firms, homogeneous products, simultaneous decisions, non-cooperative
DIFFERENCES:
Feature | Cournot | Bertrand
Decision var. | Quantity | Price
Reaction fns. | Downward sloping | Upward sloping
Strategic rel. | Substitutes | Complements
Equilibrium P | P > MC | P = MC
Profits | Positive | Zero
Time frame | Long-run (capacity) | Short-run (price)
Rival expectation| Qty stays fixed | Price stays fixed

INTERPRETATION:
Cournot is appropriate when capacity decisions are the key strategic variable
(takes time to change). Bertrand is appropriate when price adjustments are the
main competitive tool and capacity is already set.

KEY POINTS FOR FULL MARKS: correct on all 6 comparison dimensions; interpretation of
when each applies.

COMMON MISTAKE: Saying both lead to same outcome. They give VERY different
prices/profits.

Q7. Compare monopolistic competition and perfect competition.

MODEL ANSWER:

SIMILARITIES:
• Many sellers (no individual market power from number)
• Free entry → zero economic profit in the long run
• Both have well-defined long-run equilibria

DIFFERENCES:
Feature | Perfect Competition | Monopolistic Competition
Products | Identical | Differentiated
Demand curve | Horizontal (flat) | Downward-sloping
Price vs. MC | P = MC | P > MC
Long-run P vs. AC | P = AC = min(AC) | P = AC > min(AC)
Excess capacity | None | Yes (LR)
Market power | None | Some (from differentiation)

KEY INSIGHT: Both have free entry and zero long-run profit, but monopolistic
competition's product differentiation creates persistent market power (P > MC)
and excess capacity — an efficiency loss absent in perfect competition.

KEY POINTS FOR FULL MARKS: LR zero profit in both; P = MC vs P > MC; excess capacity.
COMMON MISTAKE: Thinking monopolistic competition is inefficient because P > MC.
It's inefficient in that sense, but consumers value variety — there's a trade-off.

CATEGORY 4: CASE/EXAMPLE QUESTIONS

Q8. Numerical Problem: Solve for Cournot equilibrium. P = 100 − Q, two firms, MC
= 10.

MODEL ANSWER (step-by-step):

SETUP: Q = q₁ + q₂; P = 100 − (q₁ + q₂); MC₁ = MC₂ = 10

STEP 1 — Firm 1's profit: π₁ = (100 − q₁ − q₂ − 10) × q₁ = (90 − q₁ − q₂)q₁

FOC: dπ₁/dq₁ = 90 − 2q₁ − q₂ = 0 → q₁ = 45 − q₂/2 ← Firm 1 reaction fn

STEP 2 — Firm 2 (symmetric): q₂ = 45 − q₁/2 ← Firm 2 reaction fn

STEP 3 — Solve: substitute q₂ into Firm 1's reaction:

q₁ = 45 − (45 − q₁/2)/2 = 45 − 22.5 + q₁/4
3q₁/4 = 22.5 → q₁* = 30 → q₂* = 30

STEP 4 — Market outcomes:

Q* = 60, P* = 40, π₁ = π₂ = (40−10)×30 = 900, Total π = 1,800

Compare: Monopoly → Q=45, P=55, π=2,025 | Competition → Q=90, P=10, π=0

KEY POINTS FOR FULL MARKS: correct FOC, both reaction functions, simultaneous
solution, final market outcomes, and comparison table.

COMMON MISTAKES: Not setting up profit correctly; using MR = market MR (wrong —

must account for firm's impact on price); forgetting to verify both firms are optimal.

Q9. Case: Why is Pepsi's price different from Coke's in Bertrand equilibrium with
differentiated products?

MODEL ANSWER:
In Bertrand competition with horizontally differentiated products, firms face different
demand curves based on their product characteristics, brand loyalty, and costs.

The equilibrium prices of Coke and Pepsi need NOT be equal because:

1. DIFFERENT DEMAND ELASTICITIES:

Pepsi may face more price-sensitive (elastic) demand than Coke.
 Higher elasticity → optimal price closer to MC → lower equilibrium price.

2. DIFFERENT MARGINAL COSTS:

If Pepsi has lower production costs (MC), its optimal price will be lower.

3. DIFFERENT BRAND POSITIONING:

Coke's stronger brand loyalty → less elastic demand → higher optimal price.

GENERAL PRINCIPLE: Each firm sets price based on its own demand elasticity and MC:
P* = MC × [ε/(ε−1)] (Lerner index condition)

KEY POINTS FOR FULL MARKS: understand that differentiated products → different
demand curves → different optimal prices.

COMMON MISTAKE: Assuming firms must charge the same price in equilibrium.

CATEGORY 5: CRITICAL THINKING QUESTIONS

Q10. 'Neither product differentiation alone nor few competitors alone is enough to
guarantee positive profit.' Discuss.

MODEL ANSWER:
This statement directly challenges the intuition that either market power from
differentiation or oligopolistic concentration guarantees positive profits.

EVIDENCE FOR THE STATEMENT:

1. MONOPOLISTIC COMPETITION (differentiation ≠ positive long-run profit):

• Many firms + horizontally differentiated products
• Each firm has a downward-sloping demand (some market power)
• BUT: free entry → profits attract rivals → demand shifts left → P → AC
• Long-run: economic profit = 0, despite product differentiation

2. BERTRAND HOMOGENEOUS OLIGOPOLY (few firms ≠ positive profit):

• Only 2 firms (classic oligopoly) with IDENTICAL products
• But price competition → each undercuts the other → P = MC
• Result: zero profit even with only 2 firms in the market

COMBINED INSIGHT:
Positive profit requires BOTH:
(a) Some barrier to entry OR limited competition (to prevent zero-profit entry)
AND
(b) Some insulation from brutal price competition (quantity competition or differentiation)
 The Cournot model achieves (b) via quantity competition → reaction functions
slope down → passive rivals → positive profit sustained.

CONCLUSION: Market structure analysis must examine BOTH the competitive mechanism
(quantity vs. price) AND entry conditions simultaneously.

KEY POINTS: name both examples, explain mechanism for each, state the joint condition.
COMMON MISTAKE: Only discussing one example or not linking to entry conditions.

Q11. Discuss the first-mover advantage in the Stackelberg model and its
limitations.

MODEL ANSWER:

FIRST-MOVER ADVANTAGE:
In Stackelberg oligopoly, the leader moves first by committing to a quantity.
By choosing a HIGH output level and committing credibly, the leader forces the
follower (via the follower's downward-sloping reaction function) to reduce output.

Compared to symmetric Cournot:

• Leader produces MORE (e.g., 45 > 30) → higher market share
• Leader earns MORE profit (e.g., 1,012.5 > 900)
• Follower produces LESS (22.5 < 30) → lower profit (506.25 < 900)
• Market price is LOWER (32.5 < 40) → more output overall

ECONOMIC INTUITION:
The leader uses its first move to 'strategically pre-empt' the follower,
leaving the follower a smaller residual market to serve profitably.

LIMITATIONS / COMMITMENT PROBLEM:

1. AFTER the follower decides, the leader BENEFITS from changing decision:
→ Producing 45 is only optimal IF follower chooses 22.5
→ If follower ignores leader's commitment, leader may want to reduce output

2. The follower may DISBELIEVE the leader's commitment to high output:

→ Follower increases production → both end up back at Cournot

3. First-mover advantage ONLY holds if the commitment is CREDIBLE:

→ Physical capacity investment, long-term contracts, irreversible decisions
→ See Chapter 14 for strategic commitment mechanisms

KEY POINTS: first-mover advantage math; why follower backs down; commitment problem;
credibility requirement.
COMMON MISTAKE: Assuming the leader always benefits — benefit requires credible
commitment.
 Q12. How does product differentiation resolve the Bertrand Paradox?

MODEL ANSWER:

THE PARADOX RESTATED:

Bertrand homogeneous duopoly → P = MC → zero profit
(paradox: duopoly gives same result as perfect competition)

HOW DIFFERENTIATION RESOLVES IT:

When products are HORIZONTALLY DIFFERENTIATED:

1. DEMAND IS NO LONGER 'WINNER-TAKE-ALL':

In homogeneous Bertrand, undercutting by 1 cent captures ALL customers.
With differentiation, undercutting by 1 cent gains SOME customers, not all.
→ Some consumers prefer the rival's product even at a slightly higher price.

2. EACH FIRM FACES A DOWNWARD-SLOPING DEMAND CURVE:

→ Firm has market power → optimal to price ABOVE MC

3. REACTION FUNCTIONS SLOPE UPWARD BUT LEAD TO P > MC:

→ Unlike homogeneous Bertrand, equilibrium has POSITIVE profit for both firms

4. STRONGER DIFFERENTIATION = MORE MARKET POWER:

→ Less price sensitivity → prices further above MC → higher profits

MATHEMATICAL INTUITION:
With differentiation, ∂Q_i/∂P_j < |∂Q_i/∂P_i| (own-price effect dominates)
→ Imperfect passthrough of rival's pricing → market power retained

KEY POINTS: winner-take-all breaks down; downward-sloping demand; P > MC; strategic
complements.
COMMON MISTAKE: Confusing horizontal differentiation (this) with vertical (not covered here).

EXAM QUICK-REFERENCE: All Questions at a Glance

# Question Key Points Common Mistake
Q Define competitive Few firms; rival decisions matter; Conflating with collusion
1 interdependence strategic models
Q Define residual D_res = D_mkt − S_fringe; Saying dominant firm competes
2 demand dominant firm = monopolist on with fringe
residual
Q Bertrand Paradox Duopoly → P=MC, zero profit; Forgetting it resolves with
3 disappears with differentiation differentiation
Q Cournot step-by-step FOC, reaction fns, simultaneous Using market MR instead of firm's
4 solution, Nash condition MR
Q SR vs. LR SR: P>AC (profit); LR: tangency, Saying P=MC in long run
5 monopolistic comp. P=AC, P>MC (WRONG)
Q Cournot vs. Bertrand 6 dimensions: var, slope, Saying outcomes are similar
6 compare complements, P, profit, time
Q Monopolistic vs. Both: zero LR profit. Diff: P>MC vs Ignoring excess capacity
7 perfect comp. P=MC; excess capacity
Q Numerical: Cournot Step-by-step: profit → FOC → Wrong FOC or forgetting Nash
8 solution reaction → solve → outcomes check
Q Why Pepsi ≠ Coke Different demand elasticities, MC, Assuming equal prices in
9 price brand positioning equilibrium
Q Differentiation/ MonComp + Bertrand hom → zero Only giving one example
1 concentration ≠ profit profit; need barriers + qty comp
0
Q First-mover Leader produces more, earns Ignoring credibility requirement
1 advantage more; commitment problem
1
Q Differentiation Not winner-take-all; downward D; Mixing horizontal/vertical
1 resolves Bertrand P>MC; complements differentiation
2

Good luck on your exam! 🎓

Chapter 13 — Market Structure & Competition | Academic Year 2025–2026