Cournot Competition

DEFINITION of 'Cournot Competition'

An economic model that describes an industry structure in which competing firms that make the same homogeneous and undifferentiated product choose a quantity to produce independently and simultaneously. The Cournot Competition model makes a number of assumptions – the firms cannot collude or form a cartel, and they seek to maximize profit based on their competitors’ decisions. In addition, each firm’s output decision is assumed to affect the product price. French mathematician Augustin Cournot introduced the model in 1838. The basic version of the Cournot model dealt with a duopoly, or two main producers in a market. While it remains the standard for oligopolistic competition, the model can be extended to include multiple firms.

BREAKING DOWN '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, which is defined as an outcome from which neither player would like to deviate unilaterally.

However, the model also has some drawbacks based on its assumptions that may be somewhat unrealistic in the real world. First, 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.

Second, Cournot shows that a duopoly could form a cartel and reap higher profits by colluding than from competing against each other. 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 OPEC).

Third, 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. While 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.

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