Question

How would the no-entry diagrams (Figure 4.6 in CP) change if fringe firms had the usual U-shaped average and marginal cost curves? Assume that because of a barrier to entry, there are only n fringe firms. Describe the types of possible equilibria.

Answer 1

Provided n is large in number, the fringe supply curve is horizontal up to the maximum output that the fringe firms can able to
collectively produce at a minimum average cost(AC). The residual demand curve faced by the dominant firm therefore
also has a horizontal section.

(1) If the dominant firm's marginal cost curve cuts the upper section of the residual marginal revenue curve (at a
point like A) then,  price is above the fringe firms' minimum average cost, the fringe firms collectively produce Qf1,
and the dominant firm will meet the residual market demand,
(2) If the dominant firm's marginal cost curve cuts the horizontal section of the residual marginal revenue curve
(at a point like B) then,  price is equal to the fringe firms' minimum average cost, then between zero and n fringe firms
jointly produce Qf2, and the dominant firm meets the residual market demand, Qd2.
(3) If the dominant firm's marginal cost curve cuts both the upper and the horizontal section of the residual
marginal revenue curve then,  the equilibrium may be of type (1) or (2), depending on which dominant firm earns highest profit.
(4) If the dominant firm's marginal cost curve cuts the lower section of the residual marginal revenue curve (at a
point like C) then, price is below the fringe firms' minimum average cost and no fringe firm produces. The dominant
firm is effectively works as a monopoly producing the entire market demand Qd4