Duopoly and Oligopoly Market Structure

A Duopoly is market situation with two producers

(sellers)
And an Oligopoly is a market consisting of a number of
sellers
The number of sellers is sufficiently small such that
changes in actions of any single Seller have a
significant impact upon the decision of the other
Sellers
Interdependence of actions of the sellers is the
essential feature of both the market structures

Duopoly
Duopolyand
andOligopoly
OligopolyMarket
MarketStructure
Structure
Note that distinguishing Oligopoly from Perfect
Competition on the basis of the number of sellers or
product differentiation is not sufficient
If the effect of output variations of one Seller on the
profits
other sellers is insignificant that is
of
i

q j

where (i j )

Then it satisfies the basic requirement of Perfect

Competition or many seller case of monopolistic
competition

However,

i
0
q j

where (i j )

Then the industry is Duopolistic or Oligopolistic,

Here the (p,q) combination and the profit of a seller
depends on the actions of all the sellers in the market

Duopoly and Oligopoly Market Structure

Control
A Seller in Duopoly or Oligopoly can control his own
Output level (or price if product is differentiated)
But he has no control over the output levels of
others
Profit of any Seller depends on the output level of
all other Seller
Hence, profit of each seller is result of interactions
of the decisions of all the market members

Duopoly and Oligopoly Market Structure

Solution-Behavioral Assumptions
The solution to duopolistic/oligopolistic market
depends on the various behavior assumptions
There are no generally accepted behavioral
assumptions about duopolistic/oligopolistic markets
Hence a particular solution to such market is based
on a given set of assumptions

Quasi-Competitative Solution
A solution based on the assumption that each firm follows
P=MC rule
Consider a market with two firms producing a
homogeneous product q
The inverse demand function states price as a function of
the aggregate
p F (quantity
q q ) sold
1

Where q1 and q2 are the Duopolists output levels

The Revenue function of each duopolist is given by

R1 p.q1 q1 F (q1 q2 );
R2 p.q2 q2 F (q1 q2 );

R1 R1 (q1 , q2 )
R2 R2 (q1 , q2 )

Hence Revenue of each seller depends on his own output

level and the output level of others
The profit of each seller is given by

1 R1 (q1 , q2 ) C1 (q1 );

2 R2 (q1 , q2 ) C2 (q2 )

Quasi-Competitative Solution
Using the Condition P=MC, we get the QuasiCompetitative Solution

p F (q1 , q2 ) C1(q1 );

p F (q1 , q2 ) C2 (q2 )

Solving the above for p, q1 and q2 will give us a QuasiCompetitative Solution

q , q , p
*
1

*
2

This may or may not be achieved depending on if the behavioral

assumption
is satisfied
Let the Demand
and Cost functions be

p 100 0.5(q1 q2 );

C1 5q1 ;

C2 0.5q22

Applying the above rule, gives

q1 185;

q2 5;

p 5; 1 0;

2 12.5

Curnot Solution

Curnot solution to Duopoly/Oligopoly market structure is associated wit

ch Economist Augustin Curnot

e also firms (1 and 2) are assumed to produce a homogeneous product

mption:

firm assumes that the quantity supplied by his rival is invariant w.r.t h
ntity variations

ach firm treats the output of other firm as given/fixed (independent of h

ntity decisions) and decides his own output level so as to max profits

Firm 1 maximizes his profits w.r.t. q1, while treating q2 as fixed

the Firm 2 maximizes his profits w.r.t. q2, while treating q1 as fixed

Curnot Solution

two firms (1 & 2) each owning a mineral well and operating with zero co

he market demand for their output is

Price

p F ( q1 q2 )

h firm treats the output of the competitor as given

C

pose, Firm 1 starts first producing mineral water

P

ill produce the mineral water up to a level where

P1
=MC; That is OA, and sell it at price P

ow suppose that Firm 2 joins production

rm 2 assumes that Firm 1 will keep its output fixed at OA

en the relevant demand curve for Firm 2 is given CD

rm 2 will equate MR=MC and produce half of AD = AB

a result price will fall to P1

MR2

MR1
A

D
B
Quantity

Curnot Solution

hus Firm 1s Initial output level is

q1

1
2

m 2 will assume that Firm 1 will retain

output at same level, and produce
1 1 1
q2

4 2 2

Price

P
P1

w, Firm 1 will assume that Firm 2 will retain

output at same level
hen, Firm 1 will produce output
q1

MR2

MR1
o

1
1
3
1
2
4
8

D
Quantity

Firm 2, will react to the output decision of Firm 1 and produce

q2

1
3
5
1

2
8
16

ehave Naively, without learning from past experience, this action react

rocess, the output of firm 1 falls and Firm 2 rises

Curnot Solution

ly equilibrium occurs at point when each firm produces 1/3 of Total mar

he output of Firm 1 in successive periods is

1
1 q1
2
1
1
3 1 1
2 q1 1
2
4
8 2 8
1
5
11 1 1
1
3 q1 1

; ........

2
16
32 2 8 32
Output of 1 declines gradually and at equilibrium q1 is
1 1
1
1
q1*

...........
2 8 32 128
2
3

1
1
1
1
1
1
1
1

q1
.

.......

2 8 8 4 8 4
8 4

The expression in parenthesis is declining GP

a
1
1
S
, where a , r
1 r
8
4
Thus
1
18
1
q1*

2 1 (1 4) 3

Curnot Solution

milarly the output of Firm 2 in successive periods is given by

1 1
1

2 2
4
1
3
5
1
1
3 q2 1

;
2
8
16 4 16
2 q2

........

utput of 2 increases at decreasing rate and at equilibrium q2 is

1 1 1 1 1
q .

4 4 4 4 4
*
2

1 1

4 4

...........

This is an expression for declining GS

14
1
q2*

1 (1 4) 3

s if there are n firms, the equilibrium will occur when each firm will pro

qi*

1
n 1

where

i 1, 2....n

Curnot Solution
Consider a market with two firms (1 & 2) which produce a
homogeneous product Q
The inverse demand function they face is given as

p F (q1 q2 )

The Revenue function of each duopolist is given by

R1 p.q1 q1 F (q1 q2 );
R2 p.q2 q2 F (q1 q2 );

R1 R1 (q1 , q2 )
R2 R2 (q1 , q2 )

Hence Revenue of each depends on his own output level

and the output level of others
The profit of each is given by

1 R1 (q1 , q2 ) C1 (q1 );

2 R2 (q1 , q2 ) C2 (q2 )

Curnot Solution
As each firm assumes others output fixed, we max. each
profit function w.r.t to their respective output levels

1 R1 (q1 , q2 ) dC1

0;
q1
q1
dq1
2 R2 (q1 , q2 ) dC2

0;
q2
q2
dq2

R1 dC1

; MR1 MC1
q1 dq1
R2 dC2

; MR2 MC2
q2 dq2

And Second order condition requires that

i Ri
d Ci

0; or
2
2
2
qi
qi
dqi
2

Ri
d 2 Ci

2
2
qi
dqi

Note that this profit Max. differs from monopolist with two plants,
where single producer controls the output levels at both plants
Here each Duopolist Max. his profit w.r.t. single variable under his
control i.e., his output level

Curnot Solution

ole process towards equilibrium can be described by Reaction functions

ction functions can be obtained by solving the respective optimality con

nd q2

1' s q1 1 ( q2 );

2' s q2 2 ( q1 );

ction functions express the output level of each firm as a function of riv
For any specified value of q2, Firm 1s reaction function gives
the output level q1 which is profit max. for 1
Similarly, 2s reaction function gives the output level q2
which is profit max. for 2
The Equilibrium solution is given by the output levels q1 and q2
which satisfy these functions

The Equilibrium occurs when the values of q1 and q2 are such

that each duopolist max. his profit for given output levels of
others
equilibrium neither firm desires to alter his output

Curnot Solution
Suppose Demand and Cost functions are given as

p A B (q1 q2 );

C1 a1q1 b1q12 ;

C2 a2 q2 b2 q22

he profit functions of the Duopolists are

1 Aq1 B (q1 q2 )q1 a1q1 b1q12 ;

2 Aq2 B (q1 q2 )q2 a2 q2 b2 q22

ting partial derivatives w.r.t. respective output levels =0

1
A B (2q1 q2 ) a1 2b1q1 0
q1
2
A B (q1 2q2 ) a2 2b2 q2 0
q2

The corresponding Reaction Function are

A a1
B
q1

q2 ;
2( B b1 ) 2( B b1 )

A a2
B
q2

q1
2( B b2 ) 2( B b2 )

Curnot Solution

A a1
B
q1

q2 ;
2( B b1 ) 2( B b1 )

A a2
B
q2

q1
2( B b2 ) 2( B b2 )

As B, b1 and b2 are all positive, a rise of either duopolists

output will cause a reduction of the others optimum output
The Equilibrium is given by solving the above equations for q1
and q2, that is

2( B b2 )( A a1 ) B ( A a2 )
q
4( B b1 )( B b2 ) B 2
*
1

2( B b1 )( A a2 ) B ( A a1 )
q
4( B b1 )( B b2 ) B 2
*
2

The Second order condition are satisfied

2 1
2( B b1 ) 0,
2
q1

2 2
2( B b2 ) 0
2
q2

Curnot Solution
Now, the earlier Demand and Cost functions give
the solution

p 100 0.5(q1 q2 );

C1 5q1 ;

C2 0.5q22

The Respective reaction functions for this duopolistic market

are

q1 95 0.5q2 ;

q2 50 0.25q1

And the Curnot Equilibrium Solution is

q1* 80;

q2* 30;

p 45;

1 3200;

2 900

Comparison with Quasi-Competitative Solution the Curnot

Duopolist produces a smaller total output, at higher prices,
and also for larger profits

Curnot Solution

Graphically the reactions functions are given as

Q2

Q2
1s Reactions

11
q21

23

2s Reactions

22

q22

12

q20

24

13
14
q11q12

q21

Q1

14 13 12 11

q11 q12

1s Reactions

q2*

e
2s Reactions

q1*

21

Q1

24 23 22 21

Collusion Solution

ssume that Duopolists recognize their interdependence and agree to ac

imize the total profits
Then both the variables are under a single control and the
industry in effect is monopoly with two plants
The equilibrium condition is given by

MR(q1 q2 ) MC1 MC2

Under such solution total price will be higher and total output
smaller than in Curnot Solution
The collusion solution is advantageous as it results in increase
in total profits
Here the firm with lesser costs will produce more and will enjoy
higher profits

Stackelberg Solution

re, we assume that one firm will act as Leader and other will act as Foll

e Leader is able to determine reaction function of his Rival and takes it

nsideration while max. his profits

en the Leader maximizes his profits like a Monopolist

Generally, Leaders profits function is given as,

1 h1 (q1 , q2 );

2 h2 (q1 , q2 )

hile assuming rivals output will vary in response, the Leader Max profit

d 1 h1 h1 q2

0;
dq1 q1 q2 q1
And the Rivals response is given by

q2
q1

and

q1
q2

d 2 h2 h2 q1

0
dq2 q2 q1 q2
The output of the Rival is
assumed to
Vary
qin response q
2

q1

0 and

q2

Stackleberg Solution

Suppose, Firm 1 plays as Leader and Firm 2 as

Follower
Then Firm 1 assumes 2s reaction function is
valid
Thus, Firm 1s Profit function is given by

1 h1 q1 , (q1 ) ,

where q2 (q1 )

here, Firm 1s (Leader) profit is function of

q1 alone
And Firm 1s maximizes profit w.r.t. single
d 1
variable q1
h q , (q ) 0

dq1

Solving it for q1 will give 1s profit max. output when

he plays Leader (q1L)
Substituting this q1L into 2s reaction function, that is

q2 F (q1L )
This will give profit maximizing q2 when 2 plays as
Follower (q1F)

Stackleberg Solution

, the leadership output of Firm 2 (q2L) and Followership output of firm

etermined

ere are Four possibilities and the corresponding Four Outcomes

1 Leader ; 2 Follower true q1L , q2 F

1 Follower ; 2 Leader true q1F , q2 L

1 Follower ; 2 Follower true q1F , q2 F Curnot Solution

1 Leader ; 2 Leader true # Stackelberg Disequillibrium

The firms will choose the role which gives them maximum
profit

Stackleberg Solution
Graphically Illustration;
2s q

1s Reaction

21
q2L

2s q
E

22

1s Reaction

12
2s Reaction
q2F

E1

2s
Reaction

11
q1F

1s q

q1L

1s q

Firm 1 Follower, Firm 2 Leader (E) Firm 1 Leader, Firm 2 Follower (E

Product Differentiation

ose producers in oligopolistic market produce differentiated products

each producer faces distinct demand curve

us the demand function of each producer is given by

qi f i ( P1 , P2 ,.....Pn )
q
Here i 0;
Pi

where

and

q j
Pi

i 1,2....n

This first condition implies that an increase in price of ith seller will
result in reduction in the ith firms output demand
And the second condition implies that with the rise in price of ith seller,
the output
demand for all other sellers increases

Alternatively,

pi Fi (q1 , q2 ,.....qn );
And

p j
qi

pi
0;
qi

Solution

olution in case of two Firms is given by maximizing the respective profi

is

p1 F1 ( q1 , q2 ),
(Or ),

p2 F2 ( P1 , P2 )

q1 f1 ( P1 , P2 ),

q2 f 2 ( P1 , P2 )

1 q1 p1 F1 ( q1 , q2 ) q1 C1 (q1 );
1 h1 ( q1 , q2 )
1 h1 ( f1 ( P1 , P2 ), f 2 ( P1 , P2 ));
1 H 1 ( p1 , p2 )
Similarly for Firm Second firm,

2 h2 (q1 , q2 ) or

2 H 2 ( p1 , p2 )

ence profits of each Duopolist is a function of both the prices

nd each profit function is max. w.r.t. prices of both the commodities

Advertising Expenditure

Differentiated Duopolistic market structure advertising Outlay plays a cr

e advertising helps the firms to sell larger quantities at given prices

a given quantity at higher prices

Then the demand curves are given as

p1 F1 ( q1 , q2 , A1 , A2 ),

p2 F2 ( P1 , P2 , A1 , A2 )

And the profit function are as

1 F1 (q1 , q2 , A1 , A2 ) C1 (q1 ) A1
2 F2 (q1 , q2 , A1 , A2 ) C2 (q2 ) A2

uopolist then Max. his profit w.r.t. his advertising expenditure and outp

Market Share Solution

e that Firm 2 desires to maintain a Fixed share of Total Sales of a differe

t regardless of effect of his actions on his short-run profit

or concern is long-run advantages that are derived from maintaining a

share

ppose, k is the share that Firm 2 wants to maintain

q2
k
q1 q2

Alternatively, it can be written as

q2 kq1 kq2 ;

or

(1 k )q2 kq1 ;

or

kq1
q2
1 k

mplies that a quantity change by Firm 1 will be immediately followed by

rtionate change in quantity of Firm 2

irm 1 will always be a market Leader as his actions are always followed
etermined manner

Market Share Solution

ume that Firm 1s (Leader) demand function is given as

p1 F1 ( q1 , q2 )
His profit function is

1 q1 F1 (q1 , q2 ) C1 (q1 )
q2
Substitute the

kq1
1 k

1 q1 F1 ( q1 ,

kq1
) C1 ( q1 )
1 k

ts can be maximized w.r.t. single variable q1

d 1
0
is setting
dq1 and solving for q1 will give us value of the q1

uting this value of q1 into

o sell

q2

kq1
1 k

, will give the quantity q2 whi

Market Share Solution

ssume that Firm 1s demand function is given as

p1 100 2q1 q2 ;

C1 2.5q12 ;

k
Let Firm 2 want to maintain

As

q2

ubstitute

1
3

kq1
q2 0.5q1
, then
1 k
q2 0.5q1 in the profit function

1 q1 (100 2q1 0.5q1 ) 2.5q12

1 100q1 5q12
d 1
dq1

100 10q1 0;

q1 10

ing this value of q1=10 inq2 0.5q1

q2 5,

p1 75;

, we get

1 500

Firm 1 max. his profit at q1=10 and Firm 2 reacts by producing q2=5