The Effect of Competition

• Monopoly

• Oligopoly

• Bertrand’s model

– Quantity can be easily adjusted.

• Cournot’s model

– Quantities are chosen first, and can’t be easily altered; then prices are set.

Monopolist

P* = 3

Quantity

Marketprice

Demand:p=5-q

c=1

q* = 2

=4

07/14/04 B189 - Simon Rodan 4

LRAC

# of firms

Price

1 2 3 4 5 6

Bertrand model of competition

The Oil Super Majors

Sales ($B)

Net Income ($B) ROE

Royal Dutch Shell 475 26 5%

Exxon 434 45 10%

BP 377 17 5%

Chevron 230 27 12%

Total SA 222 14 6%

Data are for FY2011

Expected Duopoly Profit

P* = 3

Quantity

Marketprice Demand:

p=5-q

c=1

q* = 2

2=2 2=2

Cournot’s Duopoly Prediction

P* = 2.33

Quantity

Marketprice

Demand:p=5-q

c=1

q* = 2.66

=1.77=1.77

1 and 2=3.54

Simulation

Cournot’s Duopoly Prediction

P* = 2

Quantity

Marketprice

Demand:p=5-q

c=1

q* = 3

=1

1,2 and 3=3

=1 =1

07/14/04 B189 - Simon Rodan 9

LRAC

# of firms

Pote

nti

al pri

ce

1 2 3 4 5 6

Cournot model of competition (quantity)

Firm Size Industry Profile

Sale

s

CR4 = 80%

Sale

s

CR4 = 8%

Industry concentration

1 2 3 4 5 6 7 8 9 10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

0

20

40

60

80

100

120

Firm rank (by sales)

Sale

s

• Industries with few firms are ‘concentrated’

• Industries with many firms are ‘fragmented’

• However, most industries have both large and small firms

Some more examples

Sale

s

CR4 = 9%CR4 = 35%CR4 = 62%

Assessing concentration

• Four Firm Concentration Ratio (CR4)– Add up the sales for all firms in the

industry– Add up the sales of the four largest firms

in the industry – Divide the second number by the first

• OR– Add the market shares of the four

largest firms (this is exactly equivalent to the first method)