Cournot’s Duopoly Model

Augustine Cournot, a French economist, published his theory of duopoly in 1838. But it
remained mainly unnoticed till 1880 when Walras called the attention of the economists to
Cournot’s work. Cournot’s model of oligopoly is one of the oldest theories of the behavior of the
individual firm and relate to non-collusive oligopoly. In the Cournot model it is assumed that an
oligopolist thinks that his rival will keep their output fixed regardless of what he might do.
Assumptions:
1. There are two firms in the market.
2. Each firm owns a mineral well and producing mineral water and the product is
homogeneous.
3. Cost of production is zero.
4. Number of buyers is large.
5. Each firm is aware of market demand, which is a straight line and sloping downward.
6. Each firm acts on the assumption that its competitor will not change the output.
7. Each firm decides its own output to maximize its profit.
8. Neither of the firms fixes the price of its product, each sell its product at the prevailing
market price.
9. Naive behavior of the firms, i.e, firms never learn from their past experience.
Explanation of the Model
In the original duopoly model of Cournot, both firms expect its competitor not to change its
output and determine its own output with a view to maximize the profit. These firms at no
stage enter into collusion, not even tacitly. Each one observes what the other is doing and
acts on the assumptions that he will continue to do the same things. In Cournot model, the
competitor adjusts with output, not prices. Cournot model can be explained with the help of
figure below. In the given figure, AB is the market demand for mineral water and OB is its
total quantity which two firms X (F x) and Y (Fy) can produce. If these firms decide to sell
maximum possible quantity, the market price will have to be ‘zero’. This will obviously the
most irrational behavior on their part and in any case they will not likely to behave in this
manner. Cournot assumes that both firms will not start the production simultaneously. Let’s
assume that Fx is the first to start the production. Since the firm desires to maximize its
profits, it will produce OJ quantity of output at which MC=MR and we know that MC=0. At
this level of output, F x will keep its output fixed at OJ, Fy considers that its own demand
curve CB. It, therefore, decides to produce JK and sells it at OP 1. Fy’s output is half of the
demand which has not met by F x. In other words, output of Fy is 1/4th of the total market.

Now, Fx will react to this situation. It observes that F y’s production has brought down the
price and it thus decides to adjust itself to the new situation. It assumes that F y will continue
to produce to JK quantity which is not supplied by F y. So Fx will produce one-half of the
market which is not supplied by F y. Since B covers one-quarter of the market, A will, in the
next period, produce ½ (1 – ¼) = ½. ¾ = ⅜ of the total market. Having noted that F x has
reduced its production, to 3/8 th of the total market, F y thinks that there is an opportunity to
expand the market. On the Cournot’s assumption, F y will produce one-half of the unsupplied
section of the market, i.e. ½ (1 – ⅜) = 5/16. In the third period Fx will continue to assume
that Fy will not change its quantity, and thus will produce one-half of the remainder of the
market, i.e. ½ (1 – 5/16). This action-reaction pattern continues, since firms have the naive
behavior of never learning from past patterns of reaction of their rival. However, eventually
equilibrium will be reached in which each firm produces one-third of the total market.
Together they cover two-thirds of the total market. Each firm maximizes its profit in each
period, but the industry profits are not maximized. That is, the firms would have higher joint
profits if they recognized their interdependence, after their failure in forecasting the correct
reaction of their rival. Recognition of their interdependence (or open collus ion) would lead
them to act as a monopolist, producing one-half of the total market output, selling it at the
profit-maximizing price ‘P’, and sharing the market equally, that is, each producing one-
quarter of the total market (instead of one-third).
Since in Cournot model, firms have a totally naïve behavior of not learning from their past
experiences, this action reaction continues unless both firms produce 1/3th of the total market.
Jointly these firms will produce 2/3 rd of the total market. The two firms each time period
maximizes their profits, but their joint profits remain less than what they could have earned
if they were in collusions. But in Cournot model, firms are not aware of the implications of
their interdependence and therefore, they make no attempt to come any understanding. In
case the two firms realize the interdependence for their profits, they will jointly cut down
their output i.e., their monopoly output and will act as monopoly. In this case, charging
monopoly price, firms will enhance their profits, though in this situation each one of them
will produce 1/4th of the total market rather than 1/3 rd of it. In Cournot model, two firms
produce 2/3rd of the total market. In case, there are three firms, they will produce 3/4 th.

Criticism:
The merit of Cournot model is that it manages to reach in equilibrium position. But it is
criticized on many grounds which are discussed below.
1. The model does not explain how long the period of adjustment will be.
2. Unrealistic assumption (two sellers).
3. Behavioral pattern of firms is naïve which is unrealistic.
4. Closed model.
5. Assumption of costless production is unrealistic.