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The basic Cournot model of oligopoly can show how product differentiation and market power can affect industry price and output However some ground work needs to be done before diving into the Cournot model with differentiation For starters standardized assumptions can not be used with differentiated products The standardized assumption is that if firm 1 undercut firm 2s price the entire market would shift to firm 1 However the entire market will not move from one market to the other even if the products are relatively identical Furthermore any differentiation will cause fewer customers to react to prices of other similar goods Suppose that a firm raises its prices slightly the firm will lose some customers but not all The rate at which the firm loses sales as prices increase will depend on the extent of product differentiation As shown in the graph below firms with varieties almost completely differentiated almost have their own market demand curve similar to the industries On the other hand firms with varieties nearly standardized can not change prices much without losing a large share of the market The firm that can differentiate its product the most can almost become a monopolist As long as firm 1 is part of the market it can not be considered a pure monopolist unless all other firms leave the market Otherwise products would have to become so differentiated that two unique markets would be created The existence of other firms or another firm affects the profit maximizing price of firm 1 As shown in the graph below as the industries average price increases so will firm 1s profit maximizing price By computing the various profit maximizing prices of firm 1 depending on the industrys average price firm 1s price reaction curve can be obtained Because firm 1s profit-maximizing price rises as the industrys average price rises firm 1s price reaction curve slopes upward Through a similar prices and assuming
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