The Cournot Duopoly Model

1999

Dr. P. LeBel Instructions:

This module has three sections: 1. The base case study; 2. The solution tableau; 3. The case study control panel. Once you have completed part one and checked your results in part two you can reset values under the control panel to set up a new problem. The intercept term of the demand equation must be greater than the intercept term of the supply equation to derive a consistent solution. The accompanying graph displays automatic solution values. Let us depart from the classical monopoly model to see what happens to an industry characterized by only two producers, i.e., a duopoly. A classic formulation of duopoly was first made by the French economist Antoine Augustin Cournot (1801-1877), in his 1838 treatise, Rec h erc h es s u r les Prin c ip es Math m atiq u es d e la Th o rie d es Ric h es s es , which was translated into English in 1897 as Res earc h es in to th e Math em atic al Prin c ip les o f W ealth . Cournot's model was based on two duopolists involved in the production of mineral water. In his model, each producer would choose a profit-maximizing level of output on the assumption that the other producer would not adjust output in response to the initial firm's output decision. As long as Cournot's dupolists do not collude or respond to each other, the resulting market equilibrium will move closer to the competitive level. Consider the following classical monopoly conditions: 1. Q= 12.00 -1.50 P The total revenue function will be: 3. TR = (P)x(Q) = Q Q Now consider the classical monopolist's total cost function: 5. TC = 2.50 Q and the corresponding marginal cost function will be: MC = dTC/dQ = The classical monopolist's equilibrium price will be: Pmon = 9. 7.
2

first, derive the corresponding inverse demand function: 2. P= Q and whose marginal revenue function will be: Q The corresponding average total cost function will be: 6. AC = TC/Q = Q/Q = The profit maximizing level of output will be: 8. Qmon = Total revenue will be: 10. TRmon = 4. MR = dTR/dQ =

The economic rate of return on sales will be: Total cost will be: Total profit will be: TCmon = 11. 12. 13. RRSales = Profit = Now consider a duopoly market, I.e., one with two producers. The original demand function now is defined as: 14. 15. 16. 17. Q = Q1 + Q2 = Q1 = P1 = TR1 = (P)(Q1) = Q1 Q 2Q 1 12.00 -1.50 P If Q2 is fixed, firm one now has a demand curve defined as: (12.00 -1.00 Q2) -1.50 P The inverse of equation 15 thus becomes the first duopolist's demand function: Q1 Q1
2

From equation 16, we now can derive the first duopolist's total revenue function: and from which we derive the corresponding marginal revenue function as: Q2 Q1 18. MR1 = dTR/dQ1 = Setting this marginal revenue function equal to the first duopolist's marginal cost, equal to: we obtain Cournot's "reaction" function: Q1 opt = f(MR=MC)= Q2 Q1 = 19. which reduces to: 20. 21. 22. Q1 = Q2 Turning to the second duopolist, we first derive the corresponding total revenue function: TR2 = (P)(Q2) = Q2 Q 2Q 1 Q2
2

whose marginal revenue function is: Q1 Q2 MR2 = dTR/dQ2 = which when set equal to the firm's marginal cost yields the (Cournot "reaction") optimal output function: Q1 Q2 = which when re-arranged for Q1 yields: Q2

23. Q2 opt = f(MR=MC)= which reduces to: 24. 26.

Q2 = Q1 25. Q1 opt = Setting equations 20 and 25 equal to each other yields the optimal output levels: Q2 opt =
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Inserting this solution value into equation 25 yields the optimal output of the first duopolist Q1 opt = , which for the two duopolists yields a total output of: When total market quantity is inserted into the original market demand function we obtain: 28. P= Now compare the duopoly solution with that of the classical monopoly one: 27.
Classical Monopoly Price Quantity Total Revenue Total Cost Profit Rate of Return Duopoly D/M Ratio: Pct.Chge.

The Cournot Duopoly Model Solution Tableau Dr. P. LeBel 1999 Let us depart from the classical monopoly model to see what happens to an industry characterized by only two producers, a duopoly. A classic formulation of duopoly behavior was first made by the French economist Antoine Augustin Cournot (1801-1877), in his 1838 treatise, Rec h erc h es s u r les Prin c ip es Math m atiq u es d e la Th o rie d es Ric h es s es , which was translated into English in 1897 as Res earc h es in to th e Math em atic al Prin c ip les o f W ealth . Cournot's model was based on two duopolists involved in the production of mineral water. In his model, each producer would choose a profit-maximizing level of output on the assumption that the other producer would not adjust output in response to the initial firm's output decision. As we will see, as long as our dupolists do not collude or respond to each other, the resulting market equilibrium output will be higher and the price will be lower than under classical monopoly. Consider the following classical monopoly conditions: 1. Q= 12.00 -1.5000 P The total revenue function will be: 3. TR = (P)x(Q) = 8.00 Q -0.67 Q Now consider the classical monopolist's total cost function: 5. TC = 2.50 Q and the corresponding marginal cost function will be: 7. 9. MC = dTC/dQ = Pmon = $2.50 $5.25 The classical monopolist's equilibrium price will be:
2

which yields the following inverse demand function: 2. P= 8.0000 -0.6667 Q =AR and whose marginal revenue function will be: 4. MR = dTR/dQ = 8.0000 -1.33 Q The corresponding average total cost function will be: 6. AC = TC/Q = 2.50 Q/Q = 2.50 The profit maximizing level of output will be: 8. Qmon = f(MR=MC)= Total revenue will be: 4.13

10. TRmon = $21.66 Total cost will be: Total profit will be: TCmon = $10.31 11. 12. Profit = $11.34 The economic rate of return on sales will be: 13. RRSales = 52.38% Now consider a duopoly market, I.e., one with two producers. The original demand function now is defined as: 14. 15. 16. 17. 18. Q = Q1 + Q2 = 12.00 -1.50 P If Q2 is fixed, firm one now has a demand curve defined as: Q1 = (12.00 -1.00 Q2) -1.50 P The inverse of equation 15 thus becomes the first duopolist's demand function: P1 = (8.00 -0.67 Q2) -0.67 Q1 From equation 16, we now can derive the first duopolist's total revenue function: TR1 = (P)(Q1) = 8.00 Q1 -0.67 Q2Q1 -0.67 Q1
2

and from which we derive the corresponding marginal revenue function as: MR1 = dTR/dQ1 = 8.00 -0.67 Q2 -1.33 Q1 2.50 ,

Setting this marginal revenue function equal to the first duopolist's marginal cost, equal to: we obtain Cournot's "reaction" function: 19. Q1 opt = f(MR=MC)= 8.00 -0.67 Q2 -1.33 Q1 = 2.50 which reduces to: Q1opt = 20. 4.13 -0.50 Q2 Turning to the second duopolist, we first derive the corresponding total revenue function:
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21. 22.

8.00 Q2 whose marginal revenue function is:

TR2 = (P)(Q2) =

-0.67 Q2Q1

-0.67 Q2

MR2 = dTR/dQ2 = 8.00 -0.67 Q1 -1.33 Q2 which when set equal to the firm's marginal cost yields the (Cournot "reaction") optimal output function: 8.00 -0.67 Q1 -1.33 Q2 = 2.50 which when re-arranged for Q1 yields: -2.00 Q2

23. Q2 opt = f(MR=MC)= which reduces to: 24. 26. 27.

Q2 = 25. Q1 opt = -0.50 Q1 4.13 8.25 Setting equations 20 and 25 equal to each other yields the optimal output level for each firm: Q2 opt = 2.75 Inserting this solution value into equation 25 yields the optimal output of the first duopolist

Q1 opt = 2.75 , which for the two duopolists yields a total output of: 5.50 When total market quantity is inserted into the original market demand function we obtain: 28. P= 8.00 -0.67 x(5.50) = $4.33 Cournot Duopoly Reaction Functions Now compare the duopoly and classical monopoly solutions: 9.00
Classical Monopoly Price Quantity Total Revenue Total Cost Profit Rate of Return $5.25 4.13 $21.66 $10.31 $11.34 52.38% Duopoly $4.33 5.50 $23.83 $13.75 $10.08 42.31% D/M Ratio: 82.54% 133.33% 110.05% 133.33% 88.89% 80.77% Pct.Change -17.46% 33.33% 10.05% 33.33% -11.11% -19.23%
8.00 7.00 6.00 5.00 4.00

3.00 2.00 1.00 0.00

24

30

36

12

15

18

21

27

33

39

42

45

First Duopolist

Second Duopolist

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48

The Cournot Duopoly Model Reset Control Panel Simulation Reference Base Case 12.00 10.00 Set classical monopoly functional price coefficient -1.5000 -2.00 Set classical monopolist's total cost coefficient 2.50 3.00
Set classical monopoly function intercept term Classic Monopoly Output Solution Classic Monopoly Price Solution Classic Monopoly Total Revenue Classic Monopoly Total Cost Classic Monopoly Profit Classic Monopoly Rate of Return Classic Monopoly Point Own Price Elasticity of Demand Single Duopolist Output Duopoly Total Output Duopoly Market Price Duopoly Market Total Revenue Duopoly Market Total Cost Duopoly Market Total Profit Duopoly Market Rate of Return Duopoly Market Own Price Elasticity of Demand 4.13 $5.25 $21.66 $10.31 $11.34 52.38% -1.9091 2.75 5.50 $4.33 $23.83 $13.75 $10.08 42.31% -1.1818
9.00

Second Duopolist First Duopolis

Dr. P. LeBel

Cournot Duopoly Reaction Functions

8.00 7.00 6.00

5.00 4.00 3.00

2.00 1.00 0.00 4 8 16 20 28 32 40 44

12 24 36 48 0

First Duopolist

Second Duopolist

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