As above, firm 1 produces a quantity of 16. 33. Firm 2 reacts to this and produces an output of 16. 33 in correspondence to firm 1. This process is often repeated and at the end, firm 1 and 2 come to equilibrium, a point of intersection between the two reaction functions. 1d. How may one or both of the firms obtain higher profits than found when acting as two Cournot firms? In order for 1 Cournot firm to gain higher profits, quantity has to be increased, thus suppressing the other firms profit as one firm is producing more than the other.
If firm 1 for example, wants to profit-maximise, they would have to equate marginal revenue and marginal cost. If marginal cost is said to be zero, the profit- maximising level of output for firm 1 is when MR takes the value of zero so therefore, it firm 1 can obtain higher profits. In order for two Cournot firms to maximise profit, for example, if Tesco and Morrison charge the same price and their marginal costs are the same, the output that they select (provided that they act independently) would be different.
If Tesco’s output is greater than Morrison’s, then it maximises its profit based on the hope of what they think Morrison’s output would be. Morrison will also choose a high output to maximise its profit based on what they think Tesco’s output will be (Besanko and Braeutigam, 2005). 2. What are the assumptions of the Cournot model? What are the assumptions of the Bertrand model? How do these assumptions impact on the prices, output and profits of firms?
There are assumptions made by Cournot model. Firstly, each of the duopolists believe that its rivals will not change its quantity- they assume the behaviour of other firms and that the current level of output of a firm will be “given” thus, they will not respond to its own production decision according to Frank. (2003). Secondly, Cournot assumes that the firms are profit-maximising. For example, both duopolists produces identical products which they sell at the same price.
Each duopolist act independently and do not collude and act under the assumption that their rivals remain constant according to Dobson and Maddala. (1989). In addition to this, according to Chacholiades. (1986), profit-maximising output is determined by each firm and “the sum of the outputs of the two firms fixed the equilibrium price on the basis of the market demand-curve”. If firms assume competitors output are constant and they a high level of output, they will incur higher profits and positive prices that will surpass marginal cost (Besanko and Braeutigam, 2005).
However, Bertrand model assumes that each firm believe that its rivals will not change its price. For example, B could enter a market which reduces price to a certain extent, thus capturing the whole market. A could lower its price below B’s set price and captures the market itself. When price equals marginal cost and when the total output produced is equal to the competitive output is when price war ends (Dobson and Maddala, 1989).
Secondly, he assumes that firms compete by setting prices and they produce homogenous goods. This result in zero profits. Firms assumes that the prices of their competitors are fixed and all the sales are captured by firms with reasonable low prices. Each firm can “undercut the prices of its competitors until price is driven down to marginal cost” (Pindyck and Rubinfeld 2005). When firms make a decision to cut prices, they charge lower than MC, thus they do not profit-maximise.