The Economics Book

90

HOW MUCH SHOULD

I PRODUCE, GIVEN

THE COMPETITION?

EFFECTS OF LIMITED COMPETITION

B

y the second half of the

17th century economists

had begun to observe the

effects in markets of monopolies

and of fierce competition. They

found that monopolies tended to

restrict output to keep prices and

profits high. Where there was

plenty of competition, prices were

driven down to the level of costs,

profits were low, and output was

high. French economist Antoine

Cournot wanted to find out what

happened when there were only a

few firms selling similar products.

Dueling duopolies

Cournot created his model based

on a duopoly of two firms selling

identical spring water to consumers.

The two firms are not allowed to

form a cartel by working together,

If there are just two

competing firms (a duopoly)

producing identical goods...

The market will be in a

Cournot equilibrium

where the two reaction

curves meet.

Each firm reacts by

selecting its best output

given the level of output the

other firm chooses (plotted

on a reaction curve).

... each firm knows that the

other firm’s output will

affect their own profits.

IN CONTEXT

FOCUS

Markets and firms

KEY THINKERS

Antoine Augustin Cournot

(1801–77)

Joseph Bertrand (1822–1900)

BEFORE

1668 German scientist Johann

Becher discusses the impact

of competition and monopoly

in his Political Discourse.

1778 Adam Smith describes

how perfect competition

maximizes social welfare.

AFTER

1883 French mathematician

Joseph Bertrand changes the

strategic choices in Cournot’s

model from quantity to price.

1951 US economist John

Nash publishes the general

definition of equilibrium for

game theory, using Cournot’s

duopoly as his first example. This is how much the

firm should produce,

given the competition.