Cournot duopoly

Cournot duopoly, also called Cournot competition, is a model of imperfect competition in which two firms with identical cost functions compete with homogeneous products in a static setting. It was developed by Antoine A. Cournot in his Researches into the Mathematical principles of the Theory of Wealth, 1838. Cournots duopoly represented the creation of the study of oligopolies, more particularly duopolies, and expanded the analysis of market structures which, until then, had concentrated on the extremes: perfect competition and monopolies. Cournot really invented the concept of game theory almost 100 years before John Nash, when he looked at the case of how businesses might behave in a duopoly. There are two firms operating in a limited market. Market production is: P (Q) =a-bQ, where Q=q1+q2 for two firms. Both companies will receive profits derived from a decision made by both on how much to produce, and also based on their cost functions: TCi=C-qi.

So, algebraically:

In order to maximise, the first order condition will be:

And, if qi=qj, then both equal:

Therefore, the reaction functions (blue lines), where the key variable is the quantity set by the other firm, will take the following form:

What all this explains is a very basic principle. Both companies are vying for maximum benefits. These benefits are derived from both maximum sales volume (a larger share of the market) and higher prices (higher profitability). The problem stems from the fact that increasing profitability through higher prices can damage revenue by losing market share. What Cournots approach does is maximise both market share and profitability by defining optimum prices. This price will be the same for both companies, as otherwise the one with the lower price will obtain full market share, which makes this a Nash equilibrium, also known for this model the Cournot-Nash equilibrium. If we consider isoprofit curves (those which show the combinations of quantities that will render the same profit to the firm, red curves) we can see that the equilibrium of the game is not Pareto efficient, since isoprofit curves are not tangent. The outcome is below that of perfect competition and therefore is not socially optimal, but it is better than the monopoly outcome. Extending the model to more than two firms, we can observe that the equilibrium of the game gets closer to the perfect competition outcome as the number of firms increases, decreasing market concentration. Comparison with Stackelberg duopolies: -Cournots model is a simultaneous game; Stackelbergs is a sequential game; -In Cournot duopolies quantity sold is the same for both firms, while in Stackelberg duopolies, the quantity sold by the leader is greater than the quantity sold by the follower; -When comparing each firms output and prices, we have:

-With regard to total output and prices we have the following:

Bertrand Duopoly
The Bertrand duopoly Model, developed in the late nineteenth century by French economist Joseph Bertrand, changes the choice of strategic variables. In the Bertrand model, rather than choosing how much to produce, each firm chooses the price at which to sell its goods. 1. Rather than choosing quantities, the firms choose the price at which they sell the good. 2. All firms make this choice simultaneously. 3. Firms have identical cost structures. 4. The model is restricted to a one-stage game. Firms choose their prices only once. Although the setup of the Bertrand Model differs from the Cournot model only in the strategic variable, the two models yield surprisingly different results. Whereas the Cournot model yields equilibriums that fall somewhere in between the monopolistic outcome and the free market outcome, the Bertrand model simply reduces to the competitive equilibrium, where profits are zero. Rather than take you through a series of convoluted equations to derive this result, we will simply show there could be no other outcome. The Bertrand equilibrium is simply the no profit equilibrium. First, we will demonstrate that the Bertrand outcome is indeed equilibrium. Imagine a market in which two identical firms sell at market price P, the competitive price at which neither firm earns profits. Implicit in our argument is our assumption that at equal price, each firm will sell to half the market. If Firm 1 were to raise its price above the market price P, Firm 1 would lose all its sales to Firm 2 and would have to exit the market. If Firm 1 were to lower its price below P, it would be operating below cost and therefore at a loss overall. At the competitive outcome, Firm 1 cannot increase profits by changing its price in either direction. By the same logic, Firm 2 has no incentive to change prices. Therefore, the no profit outcome is equilibrium, in fact Nash equilibrium, in the Bertrand model. We now demonstrate uniqueness of the Bertrand equilibrium. Naturally, there can be no equilibrium where profits are negative. In this case, all firms would operate at a loss and exit the market. It remains to be shown that there is no equilibrium where profits are positive. Imagine a market in which two identical firms sell at market price P, which is greater than cost. If Firm 1 were to raise its price above the market price P, Firm 1 would lose all its sales to Firm 2. However, if Firm 1 were to lower its price ever so slightly below P (while still remaining above MC), it would capture the entire market at a profit. Firm 2 is faced with the same incentives, so Firm 1 and Firm 2 would undercut each other until profits are driven to zero. Therefore no equilibrium exists when profits are positive in the Bertrand model.