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Cournot Model

The document discusses the Cournot and Bertrand models of duopoly in microeconomics. The Cournot model, developed by Augustin Cournot, assumes two firms producing identical products with zero costs, leading to an equilibrium where each firm produces one-third of the total market. The Bertrand model, formulated by Joseph Bertrand, describes price competition among firms producing homogeneous products, resulting in a price equal to marginal cost, similar to a perfectly competitive market.

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Roman Bhandari
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7 views

Cournot Model

The document discusses the Cournot and Bertrand models of duopoly in microeconomics. The Cournot model, developed by Augustin Cournot, assumes two firms producing identical products with zero costs, leading to an equilibrium where each firm produces one-third of the total market. The Bertrand model, formulated by Joseph Bertrand, describes price competition among firms producing homogeneous products, resulting in a price equal to marginal cost, similar to a perfectly competitive market.

Uploaded by

Roman Bhandari
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Course Title: Microeconomics-II

Course Code: ECON4006


Course Instructor: Mr. Bidhubhusan Mishra
Topic: Cournot and Bertrand Model
Cournot Model of Duopoly
• The earliest duopoly model was developed in
1838 by the French economist Augustin
Cournot.
• The original version is quite limited in that it
makes the assumption that the duopolists
have identical products and identical costs.
• Cournot illustrated his model with the
example of two firms each owning a spring of
mineral water, which is produced at zero
costs.
Assumptions
• Cournot assumed that there are two firms. Thus it
is a duopoly model.
• Cournot also assumed that there are two firms
each owning a mineral well, and operating with
zero costs. Thus this model applies to identical
product and identical cost conditions.
• He also assumed that each firm acts on the
perception that its competitor will not change its
output, and decides its own output so as to
maximize profit.
Equilibrium
Firm A: The Beginner
• Assume that firm A is the first to start producing
and selling mineral water. It will produce quantity
A, at price P where profits are at a maximum,
because at this point MC — MR = 0. The elasticity
of market demand at this level of output is equal
to unity and the total revenue of the firm is a
maximum. With zero costs, maximum total
revenue implies maximum profits. Now firm B
assumes that A will keep its output fixed, and
hence considers that its own demand curve is CD’.
Firm B: The New Entrant
• Clearly firm B will produce half the quantity
AD’, because (under the Cournot assumption
of fixed output of the rival) at this level (AB) of
output (and at price F) its revenue and profit is
at a maximum. B produces half of the market
which has not been supplied by A, that is, B’s
output is ¼ of the total market.
The Reaction Pattern of Firms
• While deciding his own output in reaction to
it’s competitors output, each firm will be
guided by the following formula.
• One Firm’s Output = ½ (Total Market Demand
– Present Output of the Other Firm)
• At the time of entry output of Firm-A is:
½ (OD’ – 0) = ½ OD’ = OA.
Firm’s Reaction
• Following OA output of Firm-A, output of
Firm-B is
½ (OD’ – ½ OD’) = ½ OD’ – ¼ OD’ = ¼ OD’ =AB
• Firm-B will react to this by producing the
following level output
½ (OD’ – ¼ OD’) = ½ OD’ – 1/8 OD’ = 3/8 OD’
Final Outcome
• This action-reaction pattern continues, since
firms have the naive behaviour of never
learning from past patterns of reaction of
their rival. However, eventually an 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
maximises its profit in each period, but the
industry profits are not maximised.
Equilibrium Output
• When Firm-A produces 1/3 OD’ the Firm-B will be
in equilibrium by producing the same level of
output.
Firm-B’s Output = ½ (OD’ – 1/3 OD’) = ½ OD’ – 1/6
OD’ = 1/3 OD’.
Firm-A’s Output = ½ (OD’ – 1/3 OD’) = ½ OD’ – 1/6
OD’ = 1/3 OD’.
• Thus both will be in equilibrium by producing one
third of output and total output will be two-third
of the total market demand.
Number of Firms & Output
• When there are two firms total output produced
is 2/3 of total market demand.
• And, in general, if there are n firms in the industry
each will provide 1 /(n + 1) of the market, and the
industry output will be n/(n + 1) = 1 /(n + 1)*n.
• Clearly as more firms are assumed to exist in the
industry, the higher the total quantity supplied
and hence the lower the price.
• The larger the number of firms the closer is
output and price to the competitive level.
Bertrand’s Model of Oligopoly
• This model was formulated in 1883 by Joseph
Louis Francois Bertrand.
• It describes interactions among firms (sellers)
that set prices and their customers (buyers)
that choose quantities at the prices set.
• This model applies to the form of
Oligopoly/Duopoly when the products are
identical.
Assumptions
• There are at least two firms producing a
homogeneous (undifferentiated) product.
• Firms compete by setting prices
simultaneously and consumers want to buy
everything from a firm with a lower price.
• Both firms have the same constant unit cost of
production, so that marginal and average
costs are the same.
Assumptions Cont...
• Both the firms have unlimited productive
capacity
• This means that a firm by setting a price just
below it’s competitor can capture the entire
market demand and it has the sufficient
productive capacity to meet the entire market
demand.
The Model
• If the initial price is higher than the marginal cost
(P > MC), then one firm may think to slightly lower
the price and meet the entire market demand.
• So he will charge P-ε price where ε is a very small
amount.
• The other firm will also react in the same way and
charge slightly lower price than the present one.
• This process of undercutting the price is called
competitive bidding.
Equilibrium
• This competitive bidding will continue until
the price becomes equal to the marginal cost.
• When P = MC, no firm will further have the
incentive to reduce the price since it will cause
loss to the firm.
• Also there will be no incentive to increase the
price since that will drive the entire market
demand to the other firm
Equilibrium Price & Output
• Thus the final price will be equal to the marginal
cost.
• This price is same as the price achieved in the
perfectly competitive market.
• Also the joint output of both the firms will also be
equal to the perfectly competitive level of output.
• Thus the Bertrand’s solution will produce the
same result as the perfectly competitive market.

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