Last Updated 08 May 2020

Tiresome tire

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The strategic approach extends the single-firm point of view by recognizing that a firm’s profit depends not only on the firm’s own actions but also on the actions of competitors. Thus, to determine its own optimal action, the firm must correctly anticipate the actions and reactions of its rivals. Roughly speaking, a manager must look at the competitive situation not only from his or her own point of view but also from rivals’ perspectives. The manager should put himself or herself in the competitor’s place to analyze what that person’s optimal decision might be. This approach is central to game theory and is often called interactive or strategic thinking. The outline of this chapter is as follows. In the first section, we describe how to analyze different types of oligopolies, beginning with Michael Porter’s Five-Forces model. Next, we introduce the concept of market concentration, as well as the link between concentration and industry prices. In the following section, we consider two kinds of quantity competition: when a market leader faces a number of smaller competitors and when competition is between equally positioned rivals. In the third section, we examine price competition, ranging from a model of stable prices based on kinked demand to a description of price wars. Finally, in the fourth section, we explore two other important dimensions of competition within oligopolies: the effects of advertising and of strategic precommitments.

Ans- Newspapers are a dramatic case in point. Based on CR4, the newspaper industry would seem to be effectively competitive for the United States as a whole. But for most major cities, one or two firms account for nearly 100 percent of circulation.3 Second, the census data exclude imports—a serious omission considering that the importance of imports in the U.S. economy has risen steadily (to some 13 percent of GDP today). In many industries (automobiles, televisions, electronics), the degree of concentration for U.S. sales (including imports) is much less than the concentration for U.S. production. Thus, many industries are far more competitive than domestic concentration ratios would indicate. Finally, using a concentration ratio is not the only way to measure market dominance by a small number of firms. An alternative and widely used measure is the Herfindahl-Hirschman Index (HHI), defined as the sum of the squared market shares of all firms: HHI s12 s22

Firm 1’s profit-maximizing output depends on its competitor’s quantity. An increase in Q 2 reduces firm 1’s (net) demand, its marginal revenue, and its optimal output. For example, if firm 1 anticipates Q 2 6, its optimal output is 9; if it expects Q 2 10, its optimal output falls to 7. In other words, Equation 9.2 sets a schedule of optimal quantities in response to different competitive outputs. For this reason, it is often referred to as the optimal reaction function. A similar profit maximization for firm 2 produces the analogous reaction function: Q2 12 .5Q 1. [9.3] Now we are ready to derive the quantity and price outcomes for the duopoly. The derivation rests on the notion of equilibrium.7 Here is the definition: In equilibrium, each firm makes a profit-maximizing decision, anticipating profit-maximizing decisions by all competitors. Before we discuss this definition further, let’s determine the equilibrium quantities in the current example. To qualify as an equilibrium, the firms’ quantities must be profit-maximizing against each other; that is, they must satisfy both Equations 9.2

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