Cournot competition

Definition

Cournot competition is a model in which firms compete on the quantity of output they produce, and each firm decides its output level based on the anticipated output levels of its competitors. This interdependence means that each firm's decision affects the market price and the profits of all firms involved, leading to a Nash equilibrium where no firm has an incentive to change its output given the output of others.

5 Must Know Facts For Your Next Test

1. In Cournot competition, firms simultaneously choose quantities, leading to a strategic interdependence between their decisions.
2. The equilibrium quantity produced by each firm in Cournot competition is determined by their marginal costs and the expected quantity produced by competitors.
3. The Cournot model predicts that an increase in the number of firms in the market will generally lead to lower prices and higher total industry output.
4. Firms in Cournot competition do not consider price as their strategic variable; instead, they focus on choosing quantities to maximize their profits.
5. The Cournot equilibrium can be derived from each firm's best response function, showing how each firm's quantity choice depends on competitors' output levels.

Review Questions

• How does Cournot competition illustrate the concept of Nash equilibrium in an oligopoly setting?
  • Cournot competition exemplifies Nash equilibrium by showing how firms choose their output levels simultaneously, taking into account the anticipated choices of their rivals. In this model, each firm settles on a production quantity where its decision maximizes profit given the output of competitors. No firm has any incentive to unilaterally change its output since doing so would not improve its profit, reflecting the essence of Nash equilibrium.
• Discuss the implications of Cournot competition for pricing strategies among firms in an oligopoly.
  • In a Cournot competition scenario, pricing strategies are indirectly influenced by firms’ quantity choices. As each firm selects an output level based on what it expects competitors will produce, this leads to a specific market price determined by total industry output. When firms collectively increase production, prices tend to decrease. Therefore, firms must carefully consider both their own production levels and those of their rivals when formulating pricing strategies.
• Evaluate how changes in cost structures impact firm behavior within the context of Cournot competition and market outcomes.
  • Changes in cost structures, such as a rise or fall in marginal costs for one or more firms, can significantly alter behavior and market outcomes in Cournot competition. For instance, if a firm's marginal cost decreases, it may choose to increase its output level, influencing competitors' responses as they adjust their production accordingly. This shift can lead to changes in overall market supply, subsequently affecting equilibrium prices. Analyzing these adjustments helps in understanding strategic decision-making among firms and broader market dynamics.

Related terms

Nash Equilibrium: A situation in which each player's strategy is optimal given the strategies of all other players, meaning that no player can benefit by changing their strategy unilaterally.

Oligopoly: A market structure characterized by a small number of firms whose decisions are interdependent, leading to competitive behaviors like price setting or output decisions.

Best Response Function: A function that represents a firm's optimal output level as a response to the output levels chosen by other firms in the market.