Cournot model - Reaction Curve PDF

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Reaction Curve...

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Q. Explain Cournot’s Duopoly Equilibrium with the aid of reaction curve. Or Cournot’s solution yields a unique and stable equilibrium under duopoly market. Explain with the help of diagram. Hint: Assumptions of the model: 1. Cournot assumed that there are two firms (duopoly market) each owning a

mineral well (homogeneous products) and operating with zero costs. (MC = 0) 2. Duopolists fully know the market demand for the mineral water. Moreover, they sell

their output in a market with a straight line demand curve. (Linear demand curve) 3. Zero Conjectural Variation: Each firm acts on the assumption that its competitor

will not change its output, and decides his output to maximize profit. What is a reaction curve? Adjustment in output/price by seller to the moves of his rival. Since in Cournot model, it is the output which is subject to the adjusting variable, output reaction curve are relevant. Explanation: In fig, output reaction curves of two producers (A and B) are shown.

Producer A will produce output OM if he were the monopolist. On the other hand, output ON will be produced under condition of pure competition since at output ON the price will be zero and therefore equal to marginal cost which is assumed to be zero in the present case. Thus, while OM is the monopoly output, ON is the purely competitive output. We assume the two producers A and B to be completely identical. Therefore, OR = OM and OS =ON Suppose producer A goes into business first and is therefore initially a monopolist. Therefore, in the beginning A will produce output OA1. Suppose now B also enters into business, B will assume that A will keep his output constant at OA1, he will produce OB1. But when A sees that B is producing OB1 he will reconsider his last decision but will assume that B will go on producing OB1. This process of adjustments and readjustments will continue until the point E is reached where the two reaction curves intersect each other and A and B are producing OAn and OBn. It is thus evident that Cournot’s solution yields a unique and stable equilibrium under duopoly....