Page 565 - Microeconomics, Fourth Edition

c13marketstructureandcompetition.qxd 7/30/10 2:15 PM Page 539

13.2 OLIGOPOLY WITH HOMOGENEOUS PRODUCTS 539

90 R (Samsung's reaction function)

Q 2 (LG's output, units per year) 45 Profit-maximizing cartel (monopoly)
S

Cournot equilibrium

FIGURE 13.4 Cournot Equilibrium 30 M E
versus Monopoly Equilibrium 22.5
If Samsung and LG behave as a profit- R (LG's reaction function)
maximizing cartel (monopoly) they will LG
produce a total of 45 units. Splitting
this equally gives each an output of
22.5. The cartel or monopoly equilib- 0 22.5 30 45 90
rium, point M, thus differs from the Q (Samsung's output, units per year)
1
Cournot equilibrium, point E.

act as a profit-maximizing cartel, they would charge this price and split the market
evenly, each producing a quantity of 22.5 (point M ). By independently maximizing
their own profits, firms produce more total output than they would if they collusively
maximized industry profits. This is an important characteristic of oligopolistic indus-
tries: The pursuit of individual self-interest does not typically maximize the well-
being of the industry as a whole.
The inability of the two firms to attain the collusive outcome occurs for the fol-
lowing reason. When one firm, say Samsung, expands its output, it reduces the mar-
ket price and thus lowers LG’s sales revenue. Samsung does not care about lowering
its rival’s revenue because it is seeking to maximize its own profit, not total industry
profit. Thus, Samsung expands its production volume more aggressively than it would
if it were seeking to maximize industry profit. If both firms behave this way, the mar-
ket price must be less than the monopoly price.
The smaller a firm’s share of industry sales is, the greater the divergence will be
between its private gain and the revenue destruction it causes by expanding its output.
This suggests that as the number of firms in the industry increases, the Cournot equi-
librium diverges further from the monopoly outcome. Table 13.4 illustrates this point

TABLE 13.4 Cournot Equilibrium for Various Numbers of Firms
Number of Firms Price Market Quantity Per-Firm Profit Total Profit

1 (monopoly) $55.0 45.0 $2,025 $2,025
2 $40.0 60.0 $ 900 $1,800
3 $32.5 67.5 $ 506 $ 1,519
5 $25.0 75.0 $ 225 $ 1,125
10 $18.2 81.8 $ 67 $ 669
100 $10.9 89.1 $ 1 $ 79
(perfect competition) $10.0 90.0 0 0