Rachel Dobbs

Rozana Himaz

Explain and compare what happens in a duopoly when the firms compete in quantities (a) simultaneously, and (b) sequentially. How do your conclusions change when firms compete in prices rather than quantities? Which model quantity-setting or price-setting is better? In a duopoly, two firms are competing in an otherwise closed market. For the purpose of analysing strategic interactions between the firms we will assume that they are producing completely identical goods and avoid the problems that can be raised by product differentiation. If this is the case there will be only four variables in the actions of the firms the price that each firm charges and the quantities that they produce.1 The way in which these decisions are made by each firm is strongly dictated by the order that the firms are allowed to choose in. If both decide at the same time this is referred to as a simultaneous game and means that both firms are forced to make their decisions without knowing the choice made by their competitor. If they are determining the quantity of a good to produce then this is know as simultaneous quantity setting and each firm must attempt to forecast what the other firms output will be in order to make a sensible decision itself.2 This situation was first analysed by a French mathematician Augustin Cournot in the nineteenth-century and the analysis of a firms attempt to predict the quantity setting actions of its (only) competitor during a single, specific period is referred to as the Cournot model. This model assumes that each firm is attempting to choose a profit maximizing output for itself through attempting to discern the decisions the other firm would make. Firm 1 will make the assumption that Firm 2 will produce an e expected output of y 2 . Firm 1 will then attempt to establish the aggregate output that will be released onto the market if it produces at a quantity of y1. This aggregate e output (Y) will be Y = y 2 + y1 and the market price that it will force in response will have the form:

P(Y) = p(y1 + ye2)

The firm making the decision (Firm 1) will naturally be seeking to make a decision that maximises its own profits and so will be attempting to fufill the profit maximization problem of:

max p(+ ye2) y1 c(y1)

Here it can be clearly seen that the profits of Firm 1 are directly dependant of the amount of the good that it believes Firm 2 will be producing. However it must also be remembered that, in a simultaneous game, Firm 2 will also be attempting to solve its own profit maximisation problem based on the amount that it believes Firm 1 is likely to produce. This means that the ultimate aggregated output of both firms will be the combined amount that each feels will maximise its profits if the other firm is also

1 2

Varian, Intermediate Economics, 498 Ibid. 507

Rachel Dobbs

Rozana Himaz

maximising its own profits this combination of output levels dictated by a reaction to another competitors expected reaction is called the Cournot Equilibrium.

Bibliography Hal R. Varian, Intermediate Economics, W. W. Norton & Company (2010)