Answer to Question #230381 in Microeconomics for Paruz

Question

elucidate price and output determination under cournot and stackelberg models of oligopoly

Answer 1

An oligopoly is a market structure in which a small number of sellers dominate and entry of new firms into the industry is limited by high barriers.

Characteristic features of an oligopoly:

1. Few firms in the industry. Usually their number does not exceed ten (steel and automotive industries, production of building materials).

2. High barriers to entry into the industry. They are associated with economies of scale. In addition to economies of scale, oligopolistic concentration is generated by the patent monopoly (Xerox, Kodak, IBM), the monopoly of control over rare sources of raw materials, and high advertising costs.

3. Universal interdependence. Each of the firms in the formation of its economic policy is forced to take into account the reaction from competitors.

Cournot duopoly model.

This model was proposed by the French mathematician A.O. Cournot. Cournot proceeded from the fact that: both firms produce a homogeneous product; they know the market demand curve; both firms make decisions about production at the same time, and independently and independently of each other; each of the firms assumes a constant release of the competitor; sellers cannot have accurate information about their mistakes regarding the selected production volumes.

The Stackelberg duopoly model is a development of the Cournot duopoly model. If in the Cournot model it is assumed that market participants do not predict the response of a competitor to their own actions, then in the Stackelberg model one market participant does not predict the behavior of a competitor, and the second takes into account the behavior of the first, knowing that the competitor will not respond to his actions. In other words, the second market participant knows that the first market participant is behaving in accordance with the Cournot model.

In other words, there is information asymmetry in the Stackelberg model, since one of the firms knows everything about the competitor's behavior, while the other does not have such information. And a firm that is able to predict the behavior of a competitor uses this information and makes an additional profit.

The point on the output diagram corresponding to the optimal output for both duopolists in the Stackelberg model always lies on the reaction line of the duopolist who acts in accordance with the Cournot model. At the same time, the second duopolist can choose the point on this line at which he gets the greatest profit. The chosen point will correspond to more production (compared to Cournot's model) for the second duopolist and less production for the first.