7 - Oligopoly with capital

Summary

To this point, all oligopoly models have assumed implicitly that firms have fixed capital stocks. Clearly, business enterprises make capital stock decisions, and such decisions are among the most important to be faced; thus it may seem strange that the topic has been avoided. The reason is that many important principles and results can be obtained without the introduction of capital stock decisions into the model. Inclusion of capital gives the firm some control over its cost function: In general, the larger the firm's capital stock, the lower its variable costs. However, this can be modeled in various ways, as the succeeding sections show. A second aspect of capital, shared by the treatment of advertising in Chapter 6, is that the size of the capital stock in period t affects the firm's position in period t + 1 and beyond. That is, the individual time periods cannot be regarded as structurally independent situations, and as a consequence, single-period Cournot equilibrium behavior cannot be equilibrium behavior for the firms. Indeed, if the investment decision of period t will not affect the cost function until period t + 1, single-period Cournot behavior will always imply zero investment. Such a suicidal policy will rarely be in the firm's best interest even if other firms act this way.

The purposes of this chapter are several. First, it may be interesting for the reader to see various ways that capital stock decisions might be incorporated into an oligopoly model.