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Cournot competition is an economic model that describes an industry structure. Rival companies offering an identical product compete on the amount of output they produce, independently and at the same time. The model is named after its founder, French mathematician Augustin Cournot.
Markets with limited competition are referred to as oligopolies. Companies operating in oligopolies often compete by attempting to steal market share from each other. One way to do this is by altering the number of goods sold.
Higher output drives down prices and lower output raises them, according to the law of supply and demand. Companies must therefore consider how much quantity a competitor is likely to churn out to have a better chance of maximizing profits.
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 that they can't collude or form a cartel. They have the same view of market demand and are familiar with competitor operating costs.
French mathematician Augustin Cournot outlined his theory of perfect competition and modern conceptions of monopoly in his 1838 book, "Researches Into the Mathematical Principles of the Theory of Wealth". The Cournot model was inspired by analyzing competition in a spring water duopoly.
The Cournot model remains the standard for oligopolistic competition but 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.
The Cournot model has some significant advantages. The model produces logical results with prices and quantities that are between monopolistic levels (low output, high price) and competitive levels (high output, low price). It also yields a stable Nash equilibrium, an outcome from which neither player would like to deviate unilaterally.
Some of the model’s assumptions can be unrealistic in the real world. 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. They're likely to be highly responsive to each other’s strategies when only two producers are in a market rather than operating in a vacuum.
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. Each company would tend to deviate from the agreed output. Look no further than the organization of the petroleum exporting countries (OPEC).
The model's critics question how often oligopolies compete on quantity rather than price. French scientist J. Bertrand attempted to rectify this oversight in 1883 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 several 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 would be difficult to find homogeneity in the products offered by two or more suppliers even with a product as basic as bottled mineral water.
A limited number of large companies dominate a particular market in an oligopoly. This doesn't preclude smaller firms from participating but the dominant companies largely share the market.
A duopoly is similar to an oligopoly but it's dominated by just two primary firms that produce or provide the same or similar products or services. Each firm plots its actions based on how it thinks the other will respond. This can greatly affect operations.
The Nash Equilibrium is a component of game theory. It states that no player's outcome can be determined by changing strategy. It was devised by 1994 Nobel Prize for Economics winner John Nash.
The Cournot economic model addresses competition between firms that provide identical or nearly identical products. They independently determine the quantity they’ll produce in anticipation of what they believe their opponent firms will do.
The strategy can produce logical results but the results can be unrealistic. Competing firms will almost certainly react to an opponent’s strategies in some measure.