Insights Into The Cournot Model
The Cournot Model is an economic model that explains how companies compete in the market for homogeneous goods and with identical costs. This model assumes that each company aims to maximize its total utility and maintains a constant production level.
It is a static competition model where the most important choice for competing companies is the volume of production. This is provided that the companies have the same costs and compete by producing homogeneous goods in a relatively static environment. The fundamental idea is to maximize total utility when total revenue (IT) and total cost (CT) are equal to 0.
Moreover, production level decisions are made independently but simultaneously. This is because the companies are producing homogeneous goods and because the production level is considered fixed.
The companies simultaneously decide on the amount of product they will produce. Each company maximizes its profits based on the expectations or forecasts about the competitor’s production decision.
The Cournot model was created by Antoine A. Cournot, through observations he made on the way companies competed in selling bottled mineral water. Cournot lived between 1801 and 1877.
Assumptions of the Cournot Model
The most important assumptions to be met are:
Competing companies produce only one homogeneous good.
The most relevant strategic decision is the amount of production.
Each company independently decides the amount it will produce, but the decisions are taken simultaneously.
Costs are equal for companies.
Companies have no restriction on producing, so they can meet the market demand.
Companies act rationally to maximize their utility.
How the Cournot Model works
For example, let’s take the following information as a reference. Assuming there is a company (Company A) that offers product x to the market. If only this company participates in the market, the company would maximize its total revenue by selling 600 units at a price of $6.
Now, if a second company (Company B) enters the competition. This means that Company B’s demand curve is given by the total market demand minus the 600 units sold by Company A. The demand curve is thus = 1200-600 =600. Therefore, Company B maximizes its total revenue by selling 300 units at a price of $3.
Finally, both companies maximize their revenue by selling 400 units at a price of $4.
How is Equilibrium Reached?
Similarly, if Company A reacts again, its new demand curve is established by subtracting the 300 units offered by Company B from the total market demand. The new demand curve is obtained = 1200-300 =900. So, Company A will maximize its revenue by selling 450 units at a price of $4.50.
Then, Company B reacts and its new demand curve results from 1200-450 = 750. So, it maximizes its utility by selling 375 units at a price of $3.75.
