Quantity Competition 361innovation, marketing, and advertising) encompassed by oligopoly. In this sec-
tion, we examine quantity competition in a pair of settings. In the following
section, we take up different kinds of price competition.A Dominant Firm
In many oligopolistic industries, one firm possesses a dominant market share
and acts as a leader by setting price for the industry. (Price leadership also is
possible among equals.) Historically, one can point to dominant firms, such
as General Motors in the automobile industry, Du Pont in chemicals, and
U.S. Steel. Firms that currently hold dominant market shares include IBM
in mainframe computers, eBay in online auctions, Federal Express in
overnight delivery, Intel in microchips, and Microsoft in PC software, to name
just a few.
What are the implications of price leadership for the oligopoly market? To
supply a precise answer to this question, we must construct a tractable and real-
istic model of price behavior. The accepted model assumes that the dominant
firm establishes the price for the industry and the remaining small suppliers sell
all they want at this price. The small firms have no influence on price and
behave competitively; that is, each produces a quantity at which its marginal
cost equals the market price. Figure 9.2 depicts the resulting combined supply
curve for these small firms. The demand curve for the price leader, labeled d
in the figure, is found by subtracting the supply curve of the small firms from
the total industry demand curve. In other words, for any given price (see P*
and Pin the figure), the leader’s sales quantity is equal to total market demand
minus the supply of the small firms, that is, the horizontal distance between
curves D and S.
Once the dominant firm anticipates its net demand curve, it sets out to
maximize its profits in the usual way: It establishes its quantity where marginal
revenue (derived from curve d) equals marginal cost (curve MC). In Figure 9.2,
the leader’s optimal price is P*, its output is Q*, and the small firms’ combined
output is QS. A numerical example illustrates the result. Suppose that total
market demand is given by QD 248 2P and that the total supply curve of
the 10 small firms in the market is given by QS 48 3P. The dominant firm’s
marginal cost is MC .1Q. Then, the dominant firm determines its optimal
quantity and price as follows. The firm identifies its net demand curve as Q
QDQS [248 2P] [48 3P] 200 5P, or equivalently, P 40 .2Q.
Setting MR MC implies 40 .4Q .1Q, or Q* 80 units. In turn, P* 40
(.2)(80) $24. Therefore, QS 48 (3)(24) 120; thus, each of the 10 small
firms supplies 12 units.
In effect, the dominant firm makes the first (and, of course, the most
important) strategic move in the market, with the remaining smaller firms
responding to its actions. The important strategic consideration for the dominantc09Oligopoly.qxd 9/29/11 1:32 PM Page 361