11.10 : Equilibrium in a Cournot Oligopoly

In the Cournot model, businesses compete based on the assumption that each firm chooses its production quantity by presuming its rivals’ output levels. No firm has an incentive to change its production quantity given the rivals’ output levels, resulting in a stable market price where all firms maximize their individual profits.

Consider two companies that produce identical goods, such as two automobile manufacturers. Initially, Company A decides to produce 50 cars as a profit-maximizing output level. Company B responds by producing 25 cars, assuming that Company A will not change its production quantity. However, based on its reaction function, Company A adjusts its output to 40 cars. In turn, Company B increases its production to 30 cars. This adjustment continues until both companies reach an equilibrium with zero marginal profit. Over time, both firms reach a point where they each produce 35 cars. At this stage, neither firm has an incentive to change its production because each has maximized its profit given the rival’s output levels. Since neither firm can improve its profit by unilaterally adjusting its output, this stable outcome is known as the Cournot equilibrium, which satisfies the Nash equilibrium condition.

Reaction curves help explain this balance. Given what the competitor is producing, these curves show the best (i.e., profit-maximizing) production level for each company. The point where the curves meet is the equilibrium, where both companies make the best possible decisions. Once they reach this point, any change by one company would reduce its profit, preventing further adjustments. The Cournot model helps explain how businesses in competitive markets make strategic decisions and gradually find a balance that benefits them both.

The Cournot model provides a fundamental framework for understanding how firms in oligopolistic markets strategically adjust their production and gradually converge to a stable competitive balance.