Stackelberg competition

Definition

Stackelberg competition is a strategic model of competition where firms make production decisions sequentially rather than simultaneously. In this framework, one firm, known as the leader, sets its output level first, and the other firm, called the follower, makes its output decision based on the leader's choice. This structure reflects the dynamics of real-world markets where firms often take turns in making strategic decisions.

5 Must Know Facts For Your Next Test

1. The Stackelberg model demonstrates how the timing of decisions affects market outcomes, showing that the leader can gain a competitive advantage by committing to an output level first.
2. In Stackelberg competition, the follower's output decision is influenced by the leader's output, allowing the follower to optimize its response based on expected market conditions.
3. The Stackelberg equilibrium involves the leader choosing an output level that maximizes its profit given the follower's reaction function, leading to a unique solution in many cases.
4. This model highlights strategic interdependence in oligopolistic markets, where firms must consider their rivals' actions when making decisions.
5. Stackelberg competition can result in higher total output and lower prices compared to Cournot competition, benefiting consumers through increased supply.

Review Questions

• How does Stackelberg competition differ from Cournot competition in terms of decision-making and market outcomes?
  • Stackelberg competition differs from Cournot competition primarily in the sequence of decision-making. In Stackelberg, one firm acts as a leader and chooses its output level first, while the other firm follows based on that decision. This sequential nature allows the leader to strategically influence market outcomes and potentially secure higher profits than in Cournot competition, where firms choose outputs simultaneously without consideration of each other's actions.
• Analyze how the concept of Nash equilibrium applies to Stackelberg competition and its implications for firms' strategies.
  • In Stackelberg competition, Nash equilibrium plays a role in determining how the follower reacts to the leader's output choice. The leader anticipates the follower's best response to its output, which forms part of its own strategic decision-making. The resulting equilibrium shows that while the leader can influence outcomes by committing first, both firms will still end up at a point where neither can benefit by unilaterally changing their output given the other’s choice.
• Evaluate the broader implications of Stackelberg competition for understanding firm behavior in oligopolistic markets and potential consumer impacts.
  • Stackelberg competition provides valuable insights into how firms operate within oligopolistic markets where strategic interaction is key. The model illustrates that leaders can leverage their position to set market conditions favorable to themselves, potentially leading to increased efficiency and lower prices for consumers. However, this also raises concerns about market power and competitive practices, as dominant firms may exploit their position at the expense of smaller rivals or overall market fairness.

Related terms

Cournot competition: A model where firms choose their output levels simultaneously, leading to a Nash equilibrium where each firm's output is determined based on the others' outputs.

Nash equilibrium: A concept in game theory where no player can benefit from changing their strategy while the other players keep theirs unchanged.

Bertrand competition: A model of competition in which firms compete by setting prices rather than quantities, leading to different market dynamics compared to quantity-setting models.