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17.1: Cournot Oligopoly
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- How do industries with only a few firms behave?
- How is their performance measured?
- Imperfect competition refers to the case of firms that individually have some price-setting ability or “market power” but are constrained by rivals.
- The Cournot oligopoly model is the most popular model of imperfect competition.
- In the Cournot model, firms choose quantities simultaneously and independently, and industry output determines price through demand. A Cournot equilibrium is a Nash equilibrium to the Cournot model.
- In a Cournot equilibrium, the price-cost margin of each firm is that firm’s market share divided by the elasticity of demand. Hence the share-weighted average price-cost margin is the sum of market squared market shares divided by the elasticity of demand.
- The Hirschman-Herfindahl Index (HHI) is the weighted average of the price-cost margins.
- In the Cournot model, larger firms deviate more from competitive behavior than do small firms.
- The HHI measures the industry deviation from perfect competition.
- The Cournot model generalizes the “inverse elasticity result” proved for monopoly. The HHI is one with monopoly.
- A large value for HHI means the industry “looks like monopoly.” In contrast, a small HHI looks like perfect competition, holding constant the elasticity of demand.
- With n identical firms, a Cournot industry behaves like a monopoly facing a demand that is n times more elastic.