What Are The Two Oligopoly Models I Will Be Outlined, Analysed And Evaluated Where Firms Set Outputs?

What Are The Two Oligopoly Models I Will Be Outlined, Analysed And Evaluated Where Firms Set Outputs?

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In this essay features of uncertainty in Oligopoly markets will be outlined, analysed and evaluated where firms set outputs. Uncertainty is ‘A consciousness of limited knowledge about present facts and future possibilities’ (Black, Hashimzade and Myles, 2009)). The common distinction between risk and uncertainty is that probabilities can be applied to future outcomes with risk, whereas probabilities cannot be applied to uncertainty- expected utility does not apply to uncertainty (Black, Hashimzade and Myles, 2009)). An Oligopoly market is one which is supplied by a small number of firms who act interdependently. Uncertainty is apparent in the form of strategic interdependence in oligopoly markets, i.e. a particular firm does not know how its competitors will act, and the actions of its competitors will directly impact them. Analysis will be made at how forming a cartel can automatically lead to uncertainty (so long as there is an incentive to cheat). The two oligopoly models I will mainly use are the Cournot model and the Stackelberg model. In the Cournot model firms move simultaneously, while in the Stackelberg model firms move sequentially. In both models firms set output levels. The analytical tools used to analyse oligopoly are iso-profit curves and reaction functions (Estrin et al. 2008). Iso-Profit curves in this essay will demonstrate the combination of two firm’s output levels that lead to a constant level of profit for one of the firms’. The reaction function of one firm describes its profit-maximising output as a function of the output of other firms (Black, Hashimzade and Myles, 2009).

The Cournot model is used to analyse how firms behave in Oligopoly markets. In this model firms’ basic decision variable is output (Est...

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...ne what output to set (Estrin et al., 2008). The two outputs are where the Stackelberg equilibrium is- this is at the point where the leader’s iso-profit curve is tangential to the follower’s reaction function. Both the Cournot and Stackelberg equilibriums are stable as if either firm changed their output the firms would arrive back at the equilibrium. This stability promotes certainty in an Oligopoly market to a certain extent. In terms of conjectural variation the follower’s is equal to zero and the leader’s is equal to the slope of the follower’s reaction function. If two firms set out to be the leader they will both have conjectural variation > 0. This means they both have an idea how the other will act to their output decisions, and can promote uncertainty. In this situation firms often look to arrange a cartel agreement which may or may not promote uncertainty.

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