Unit 23: Duopoly -Cournot, Bertrand, Stackleberg

Diti Goswami

NMIMS Bangalore

November 13, 2022

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Duopoly

A duopoly is a form of oligopoly, where only two companies dominate the

market
The companies in a duopoly tend to compete against one another,
reducing the chance of monopolistic market power.
Visa and Mastercard are examples of a duopoly that dominates the
payments industry
One disadvantage of duopolies is that consumers have little choice in
products.
Another disadvantage of duopolies is that the two players may collude and
increase prices for the consumer

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Examples of duopoly

Boeing and Airbus for their command of the large passenger airplane
manufacturing market
Apple and Samsung dominate the smartphone market
Visa and Mastercard are considered a duopoly
Coca-Cola and Pepsi in the soda industry

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Advantages of Duopoly

The two companies benefit by cooperating to improve profits

Companies do not have to constantly engage in fruitless competition or worry
about disruptors
Prices may be controlled by the rivalry between the two companies.

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Disadvantages of duopoly

Free market trading and the entrance of new companies are restricted.
Industry innovation and progress can be curtailed.
Consumers have limited options.
Price fixing and collusion may cost consumers more

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Cournot Model

Cournot competition is an economic model in which competing firms

choose a quantity to produce independently and simultaneously
The model applies when firms produce identical or standardized goods
and it is assumed they cannot collude or form a cartel
The idea that one firm reacts to what it believes a rival will produce
forms part of the perfect competition theory

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Understanding

Companies operating in markets with limited competition often compete by

seeking to steal market share away from each other
Higher output drives down prices, while lower output raises them (law of
demand).
Companies must consider how much quantity a competitor is likely to
churn out to have a better chance of maximizing profits
Efforts to maximize profit are based on competitors decisions and each
firms output decision is assumed to affect the product price
The idea that one firm reacts to what it believes a rival will produce forms
part of the perfect competition theory
The Cournot model is applicable when companies produce identical or
standardized goods (Mineral water)
It assumes they cannot collude or form a cartel, have the same view of
market demand, and are familiar with competitor operating costs.
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Advantages of the Model

The model produces logical results, with prices and quantities that are
between monopolistic (i.e. low output, high price) and competitive (high
output, low price) levels.
It also yields a stable Nash equilibrium, an outcome from which neither
player would like to deviate unilaterally

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Disadvantages of the Model: unrealistic assumptions

Assumes that the two players set their quantity strategy independently of
each other
Cournot argues that a duopoly could form a cartel and reap higher profits
by colluding. But game theory shows that a cartel arrangement would not
be in equilibrium since each company would tend to deviate from the agreed
output
Model critics question how often oligopolies compete on quantity rather than
price
Assumes product homogeneity with no differentiating factors.

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Bertrand Model

Model of competition in which two or more firms produce a homogenous

good and compete in prices
This competition in prices
Goods are perfect substitutes
Ends with the firms selling their goods at marginal costs and thus
making zero profits
The result is also called the Bertrand paradox, named after the economist
Joseph Bertrand (1822–1900).

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Assumption of Bertrand Model

Homogeneous good: completely identical in the eyes of the consumers

Competition in prices: In contrast to Cournot or Stackelberg competition,
firms do not compete in quantities but in prices

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Example

A standard example for Bertrand competition is the market for gasoline.

Petrol stations announce the price per liter and the consumers (drivers)
decide at which petrol station they refuel their car.
As petrol is a homogeneous good, most of the consumers will opt for the
petrol station with the lowest price.

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Nash Equilibrium

In the unique Nash equilibrium of the Bertrand competition model, firms set
their prices equal to marginal costs and make no profit (graph)

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Stackelberg competition

Oligopoly market model based on a non-cooperative strategic game where

one firm (the “leader”) moves first and decides how much to
produce, while all other firms (the “followers”) decide how much to
produce afterwards.
This sequential structure is the main difference to Cournot’s model,
where firms decide simultaneously on the quantities they produce

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The leader might emerge in a market because of its size, reputation,
innovative capacity, or because it simply started operating first
The leader will generally be better known and more recognized by
customers, and is therefore better placed to decide first which quantity to
sell.
The followers then decides on their output after observing the leaders
production choice
The Stackelberg leadership model was developed in 1934 by the German
economist Heinrich Freiherr von Stackelberg in his book “Market Structure
and Equilibrium”(Marktform und Gleichgewicht)

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Assumptions

The assumptions in the Stackelberg model are mostly the same as in the Cournot
model, with the important exception that firms make their production
quantity decisions sequentially
There is a fixed number of firms in the market and firms have market
power
All firms produce a homogenous good, and are subject to the same demand
and cost functions.
Firms compete in terms of the quantities that they produce (compete
for market share). This is the key difference compared to Bertrand
competition, in which firms compete in prices

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Assumptions continued

Firms decide sequentially on the output they produce which means we

have a model consisting of two distinct periods.
In the first period, the leader chooses its production quantity. This decision
cannot be changed after.
In the second period, the follower firms chooses their output after observing
the quantity chosen by the leader.
This is the key difference when compared to Cournot competition, in
which the production decisions by all firms are taken simultaneously
Each firm acts strategically on the assumption that its competitor(s) will not
change their output, and decides its own production quantity so as to
maximize its profit given its competitors output
Firms do not cooperate

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 Acknowledgement

Thank you!

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