Do competing firms react to each others actions? Discuss in the context of quantity setting duopolists and use this to explain in detail the difference between Cournot and Stackelberg models of duopoly.

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Duopoly is a type of oligopoly market structure that consists of only two large firms dominating the market, having the power over price. There are several types of oligopolies.  Firstly, Cournot competition is a model that relies in the assumption that there are two firms in the market which simultaneously choose quantity while producing homogeneous goods. Secondly, Stackelberg model is the same as the Cournot model with the exception that firms can choose quantities in sequence. Then, Bertrand competition is the model where firms simultaneously choose prices whereas in Price leadership, firms choose prices in sequence. The purpose of this essay is to analyse whether firms which compete with each other react after the actions of the others, as well as to discuss the quantity setting duopoly market structure. In this essay, I will be focus mainly in analysing the duopoly in terms of Cournot and Stackelberg models.

To begin with, in the website of the Economy Professor it is stated that, in the Cournot duopoly model, competing firms react to each other’s actions until they finally arrive at a position from which neither would wish to leave. Cournot model took its name from the French economist Antoine Augustin Cournot, who first developed this classical model of oligopoly in 1838. As mentioned in Maddala and Miller, (1989), the assumptions beyond this model are described as follows: Firstly, there are two profit-maximizing duopolists who sell at identical prices. Each firm produces an identical product while fully knowing the linear market demand curve. Then, both the two firms act independently without colluding in addition with the fact that each one of them acts under the hypothesis that its competitor’s output will remain constant, where it is now. At last, duopolists compete in quantities, while choosing quantities concurrently. A further essential assumption of this model is that each duopolist intends to maximise its profits, while expecting that its own output decision will not affect the decisions of its competitor. The market price is placed at the level where the demand is equal to the total quantity produced by the duopolists. Each duopolist gets the quantity placed by its rival as given, assess its residual demand and in the end acts as a monopolist. Both duopolists finally expand to a certain point that they have the same shares in the market and secure only normal profits.

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In Varian, (1996), it is stated that each duopolist has to forecast the other firm’s output choice. Zamagni, (1987), states that Cournot also assumes that one of the two firms is in the beginning a monopolist who at a certain point in time must meet the situation formed by the entrance of the second producer. Thinking of a market for mineral water, it can be said that when firm B discovers a new spring, it can begin to add its production to that of firm A. Obviously this will involve a sequence of adjustments which will in the end ...

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