Teaching Notes
Students viewing this material for the first time can be overwhelmed because of the number of models presented. Chapter 12 discusses ten models (with some overlap): monopolistic competition, Cournot-Nash, Stackelberg, Bertrand, price competition with differentiated products, prisoners’ dilemma, kinked demand, price leadership, dominant firm, and cartels. The reason for all the models, of course, is that there is no single oligopoly model. I try to convince students that since oligopoly theory is still evolving, it is an exciting area to study. Nonetheless, there is a great deal of material here, and you may want to concentrate on the more basic models, e.g., monopolistic competition, Cournot-Nash, prisoners’ dilemma, and cartels. You can otherwise pick and choose among the models as time and interest dictates.
When introducing the material in this chapter, start by reminding students that these market structures lie between perfect competition and monopoly. When presenting monopolistic competition, focus on why positive profits encourage entry and on the similarities and differences of this model with competition and monopoly. The example of brand competition in cola and coffee markets presented at the end of Section 12.1 facilitates a class discussion of the costs and benefits of freedom of choice among a vast array of brand names and trademarks.
The key to the Cournot-Nash duopoly model in Section 12.2 is an understanding of the way firms react to each other and the resulting reaction functions. Stress that reaction functions are graphed on axes that both represent quantities (see Figure 12.4). Once they understand reaction functions, students will be better able to follow the assumptions, reasoning, and results of the Cournot-Nash, Stackelberg, and Bertrand models. Be sure to compare the competitive, Cournot-Nash, and collusive (monopoly) equilibria as shown in Figure 12.5. Figure 12.5 gives the impression that the duopolists always have symmetric reaction curves. Exercise 2 shows that if the cost structures are not identical, the reaction curves are asymmetric.
An alternative to jumping right into the Cournot-Nash material is to start with the kinked demand model in Section 12.5. You can use this to discuss the importance of other firms’ reactions by drawing two complete demand curves through the current price-quantity point. In fact, there are many possible demand curves depending on how other firms react to a price change. For example, other firms may change price by half the amount or double the amount of the original firm’s change. There may be uncertainty about how other firms will react, which you could relate back to the material in Chapter 5 if you covered that chapter. Deriving the kinked demand and associated marginal revenue curve will be easier if you went through the effect of a price ceiling on a monopolist in Chapter 10, where there is also a kinked demand.
Section 12.4 on the prisoners’ dilemma is a student favorite. You might add some other examples such as advertising decisions where the primary effect of advertising is to take sales away from the other firm. Both firms have “high advertising” as a dominant strategy even though both would be more profitable if they each chose “low advertising” instead. Another good example is arms races between nations. Neither wants to be the one with a low number of weapons, so each stockpiles large amounts of weapons. Examples 12.2 and 12.3 deal with a pricing decision facing Procter & Gamble and together are a nice example of a prisoners’ dilemma as well as an illustration of a pricing problem in foreign markets.
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