Cournot Competition

What Is Cournot Competition?

Cournot competition is an economic model describing an industry structure in which rival companies offering an identical product compete on the amount of output they produce, independently and at the same time. It is named after its founder, French mathematician Augustin Cournot.

Understanding Cournot Competition

Companies operating in markets with limited competition, called oligopolies_,_ often compete by seeking to steal market share away from each other. One way to do this is to alter the number of goods sold.

According to the law of supply and demand, higher output drives down prices, while lower output raises them. As a result, companies must consider how much quantity a competitor is likely to churn out to have a better chance of maximizing profits.

In short, efforts to maximize profit are based on competitors’ decisions and each firm’s output decision is assumed to affect the product price. The idea that one firm reacts to what it believes a rival will produce forms part of the perfect competition theory.

The Cournot model is applicable when companies produce identical or standardized goods. It assumes they cannot collude or form a cartel, have the same view of market demand, and are familiar with competitor operating costs.

History of Cournot Competition

French mathematician Augustin Cournot outlined his theory of perfect competition and modern conceptions of monopoly in 1838 in his book, Researches Into the Mathematical Principles of the Theory of Wealth. The Cournot model was inspired by analyzing competition in a spring water duopoly.

Important

A monopoly is one firm, duopoly is two firms, and oligopoly is two or more firms operating in the same market.

The Cournot model remains the standard for oligopolistic competition, although it can also be extended to include multiple firms. Cournot’s ideas were adopted and popularized by the Swiss economist Leon Walras, considered by many to be the founder of modern mathematical economics.

Advantages of Cournot Competition

The Cournot model has some significant advantages. The model produces logical results, with prices and quantities that are between monopolistic (i.e. low output, high price) and competitive (high output, low price) levels. It also yields a stable Nash equilibrium, an outcome from which neither player would like to deviate unilaterally.

Limitations of Cournot Competition

Some of the model’s assumptions may be somewhat unrealistic in the real world. Firstly, the Cournot classic duopoly model assumes that the two players set their quantity strategy independently of each other. This is unlikely to be the case in a practical sense. When only two producers are in a market, they are likely to be highly responsive to each other’s strategies rather than operating in a vacuum.

Secondly, Cournot argues that a duopoly could form a cartel and reap higher profits by colluding. But game theory shows that a cartel arrangement would not be in equilibrium since each company would tend to deviate from the agreed output — for proof, one need look no further than The Organization of the Petroleum Exporting Countries (OPEC).

Thirdly, the model's critics question how often oligopolies compete on quantity rather than price. French scientist J. Bertrand in 1883 attempted to rectify this oversight by changing the strategic variable choice from quantity to price. The suitability of price, rather than quantity, as the main variable in oligopoly models was confirmed in subsequent research by a number of economists.

Finally, the Cournot model assumes product homogeneity with no differentiating factors. Cournot developed his model after observing competition in a spring water duopoly. It is ironic that even in a product as basic as bottled mineral water, one would be hard-pressed to find homogeneity in the products offered by different suppliers.