Which of the Cournot and Bertrand Models of Oligopoly More Realistically Reflect Firm Behaviour?

Topics: Oligopoly, Game theory, Competition Pages: 7 (2626 words) Published: November 5, 2008
There is only one model for monopoly and one for perfect competition but in contrast to these oligopolies have several models to try to explain how they react, examples of these are the kinked demand curve, Bertrand and Cournot models. A non competitive oligopoly is ‘a market where a small number of firms act independently but are aware of each others actions’ (Oligopoly, Online). In perfect competition no single firm can affect price or quantity this is due to intense competition and the relative small size of the firms, on the other hand there is a monopoly market where there is little or no rivalry and firms have control over the market. Oligopoly is a state in-between perfect competition and monopoly where the firm can change its price or quantity but has to take into account competitors reactions to these changes to determine its own best policy (Carlton & Perloff, 2005). It is argued that oligopolies are more realistic in the ‘real world’ as markets are often in-between the two extremes of perfect competition and monopoly. A good example to show how oligopolies react is the cola market in America, the Coca-Cola co is planning on raising its price by five percent the question is how will the number two producer Pepsi-cola react? Will it raise its price like Coca-Cola co or stay fast to try and gain market share (Cabral, 2000). Oligopoly models try to explain these reactions/decisions and in this essay I will look at the Bertrand and Cournot models.

The Bertrand and Cournot models are both for analysing non-competitive oligopolies and for each of these models 5 strong assumptions are made (Oligopoly, online),

1.Consumers are price takers
2.All firms produce homogenous products
3.There is no entry to the industry
4.Firms collectively have market power (so can set price above MC) 5.Each firm can either set its price or output (not other variables such as advertising)

These assumptions form the basis of both the Cournot and Bertrand oligopoly models. How each firm reacts to the other can be analysed using non corporative game theory which is based on rational, decision making individuals who may not be able to fully predict outcomes from decisions made. The Bertrand and Cournot Oligopolistic games have three common elements (Carlton & Perloff, 2005),

1.There are two or more firms (players)
2.Each firm attempts to maximise its profits (payoff)
3.each firm is aware that other firms’ actions can affect its profits

Game theory is used to explain how firms react to each others actions and how they come to a Nash equilibrium which is where if holding the strategies of all other firms constant, no firm can obtain a higher payoff by changing their strategy. So in Nash equilibrium no firm wants to change their strategy. The Cournot and Bertrand oligopoly models can be interpreted using game theory even though they were developed long before it existed. These models are single period, which means they are single period or static games where firms compete once in the period and the market then clears one and for all. Because there is no repetition the opportunity for firms to learn about each other over time is non existent and is relevant for markets that last a brief period of time (oligopoly, online).

The Cournot model was developed by the French mathematician Augustin Cournot in 1838, the basic idea behind his model of non competitive oligopoly assumes that each firm acts independently and attempts to maximise its profits by choosing its output (quantity to produce). In the Cournot duopoly model there are several basic assumptions firstly that there are 2 firms in the market, entry into the market is blockaded, the products are homogenous and both firms have constant marginal costs which means that price and profit both depend on rival firms actions (Carlton & Perloff, 2005). The model works by working out the residual demand, which is the demand for firm A’s product given the...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Bertrand and Cournot Competition Comparison Essay
  • Oligopoly and Marginal Cost Firms Essay
  • oligopoly Essay
  • Essay on Implications of the Bertrand Model
  • Oligopoly Essay
  • oligopoly Essay
  • Essay on Oligopoly
  • a more Essay

Become a StudyMode Member

Sign Up - It's Free