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Proceedings oI International ConIerence on Computing Sciences

WILKES100 ICCS 2013


ISBN: 978-93-5107-172-3
An analytic comparison between cournot`s and stackelberg
duopoly theory
Shivani Sanan
1
, Amanpreet Singh
2
and Amit Mehta
3

1
Research Scholar Punjab Technical University Jalandhar (Punjab) India
2
Department of Applied Science Institute of Engineering and Technology (Ropar) India
3
Department of Civil Engineering Sant Baba Bhag Singh Institute of Engineering and Technology (Jalandhar) India
Abstract
The objective oI this paper is to recall the duopoly models provided by Cournot and Stackelberg. The model
provided by Cournot is assumed with isoelastic demand Iunction and unit costs and comes both as static and
dynamic variant whereas Stackelberg theory belongs to the Cournot setting though unlike this, it only comes in
an equilibrium Iormat. Concerning the Stackelberg markets, we Iind that the level oI out put increases.
Stackelberg markets yield higher outputs, higher consumer rents and higher welIare levels than Cournot markets,
regardless oI whether subjects are randomly matched or play in Iixed pairs.
2013 Elsevier Science. All rights reserved.
Keywords: Duopoly, Static, Dynamics, Equilibrium.
1. Introduction
In 1838, Cournot Iirst invented the duopoly theory in which he deIined an iterative dynamical system in terms
oI reaction Iunctions which stated that given the expectation oI the other known Irom the last observations,
reaction Iunctions i.e. the production criteria oI the next iteration can be easily interpreted and hence solve a
partial optimization problem which is conditional upon the decisions oI the other player.
AIter about a century in 1934, Stackelberg proposed his theory as Stackelberg`s leadership , which stated that
the competitors will not extrapolate the expectation oI the other in advance rather Iollow a leader-Iollower
relationship where either oI the Iirms can try leadership by treating the other as Iollower and hence solve an
optimization problem. II a proper leader-Iollower relationship is established and the other player behaved as
assumed, then two Stackelberg equilibria will be added to Cournot equilibria .
II one wants to uniIy both the theories in a single model, then the best choice is to start Irom Cournot`s action
theory Ior each single period but in the next period proIits become lower than in Stackelberg leadership, i.e. the
proIits Irom Stackelberg leadership equilibrium are higher than the proIits obtained in Cournot`s equilibria but in
a dynamic perspective we will see ahead in the paper that the proIits in Cournot`s dynamics are generally higher
than proIits in Stackelberg equilibrium and so the competitors now have the choice to switch over to Cournot`s
action in the next period as the Cournot reaction Iunctions yield maximized proIits. As the competitors would
want the maximum oI the proIits in this oscillating sales policy game, a branch condition which compares the
proIits oI both the theories have to include a weighting Iactor.
2. Cournots Model Dynamic Perspective
Let
i
q represents the output oI the
th
i supplier in a duopoly game. Consider the inverse demand Iunction
2 1
1
q q
p
+
=
. . . (1)
where p denotes the prevailing market price.
Hence the proIits become,
487 Elsevier Publications, 2013
*
Corresponding author. Shivani Sanan
Shivani Sanan , Amanpreet Singh and Amit Mehta
1
2 1
1
1
sq
q q
q

+
=
. . . (2)
2
2 1
2
2
tq
q q
q

+
=
. . . (3)
where s and t are constant marginal costs oI both the Iirms respectively.
Putting the derivatives
0
1
1
=

and
0
2
2
=

and solving Ior


1
q

and
2
q
we obtain the next iteration
output oI one competitor given the last observed supply oI the other as
2
2
1
q
s
q
q =
. . . (4)
1
1
2
q
t
q
q =
. . . (5)
which are known as Cournot`s reaction Iunctions oI either oI the competitors.
As the negative supplies would result in negative proIits which does not make a sense in practical markets, so
Iirst choice is to replace the negative values with the zero branches i.e. by putting
1
q
and
2
q
both equal to zero
but then we observe that the Cournot`s reaction Iunctions come down to the axis and Iirm produces nothing and
the state is called collusion state when both the reaction Iunctions intersect each other at the origin where
0
1
= q and 0
2
= q . Further the reaction Iunctions intersect each other with inIinite slope at the origin and
produces an unstable stage but in a weak Milnor sense, we see that solutions to these type oI problems oI zero
branches are there making them stable. One can avoid the situation Irom sticking to the totally unstable origin by
assuming that iI the duopolists cannot make any proIit, then instead oI making the outputs to close down, they
keep to some small
"
epsilon
"
stand-by output.
Now the Iunction
1
q
returns a negative value iI 0
2
2
< q
s
q
i.e. whenever
s
q
1
2
>
Similarly, the Iunction
2
q
returns a negative value iI 0
1
1
< q
t
q
i.e whenever
t
q
1
1
> .
To avoid this kind oI situation we introduce the concept oI zero branches i.e we put 0
1
= q whenever
s
q
1
2
>
and put 0
2
= q whenever
t
q
1
1
> and can redeIine the outputs oI both the Iirms as Iollows

>

=
s
q
s
q q
s
q
q
1
; 0
1
;
2
2 2
2
1
. . . (6)
488 Elsevier Publications, 2013
An analytic comparison b1etween cournots and stackelberg duopoly theory

>

=
t
q
t
q q
t
q
q
1
; 0
1
;
1
1 1
1
2
. . . (7)
3. Cournots Model Equilibrium Stage
The Iixed points in Cournot`s Theory are given by putting
1
q

1
q
and
2
'
2
q q =
( )
2
1
t s
t
q
+
=
. . . (8)
( )
2
2
t s
s
q
+
=
. . . (9)
which are the outputs oI the players in the equilibrium stage.
Substituting these values obtained Irom (8) and (9) in (2) and (3), to obtain the proIits oI the competitors in
Cournot`s equilibrium as Iollows
( )
2
2
1
t s
t
+
=
. . . (10)
( )
2
2
2
t s
s
+
=
. . . (11)
To calculate the proIits in this Cournot`s dynamic process, substitute the reaction Iunctions obtained in the next
iteration i.e equations (4) and (5) into (2) and (3), to obtain
( )
2
2 1
1 sq =
. . . (12)

( )
2
1 2
1 tq =
. . . (13)

On comparing the proIits in Cournot`s dynamic process obtained in (12) and (13) and the proIits oI the
competitors in the Cournot equilibrium point obtained in (8) and (9) , we observe that in dynamic process proIits
can be considerably higher.
4. Stackelbergs Equilibrium
Stackelberg theory extends only the possibilities Ior equilibrium and it never took a dynamic perspective. Also
the proIits obtained in Stackelberg equilibrium will be compared to the proIits obtained in Cournot`s dynamic
process.
According to Stackelberg`s theory, the competitor 1 controlling the output q
1
becomes a leader, treating the other
competitor as Iollower and takes the reaction Iunction (5) oI the other Ior given and substitute in its own proIit
Iunction (2) to obtain
1 1 1
sq tq =

Putting the derivative
0
1
1
=
dq
d
, one gets,
489 Elsevier Publications, 2013
Shivani Sanan , Amanpreet Singh and Amit Mehta
2
1
4s
t
q =
. . . (14)
As mentioned above, the competitor 2 acting as Iollower now Iollows the competitor 1 and thereIore its
output
2
q
can be calculated by substituting (14) in (5),
2
2
4
2
s
t s
q

=
. . . (15)
Using these output patterns oI both the competitors, the Stackelberg leadership proIits can be calculated by
substituting (14) and (15) in the proIit equation oI Iirst competitor (2) to obtain his proIit as Iollows
s
t
4
1
=
. . . (16)
Similarly the competitor 2 can behave as a leader treating the other competitor as Iollower and hence applying the
whole process stated above Ior competitor 2 and substituting (4) in (3) and maximizing
2 2 2
tq sq =
Putting the derivative
0
2
2
=
dq
d
, one gets,
2
2
4t
s
q =
. . . (17)
As mentioned above, the competitor 1 acting as Iollower now Iollows the competitor 2 and thereIore its output
1
q
can be calculated by substituting (17) in (4), the corresponding Cournot response would be
2
1
4
2
t
s t
q

=
. . . (18)
Using these output patterns oI both the competitors, the Stackelberg leadership proIits can be calculated by
substituting (17) and (18) in the proIit equation oI second competitor (3) to obtain his proIit as Iollows
t
s
4
2
=
. . . (19)
Now we see that the proIits obtained in Stackelberg`s equilibrium are considerably higher as compared to the
proIits obtained in Cournot`s equilibrium.
Now, as the Iirm controlling production
1
q
has successively established the leadership to choose the production
2
1
4s
t
q =
and obtain the proIit
s
t
4
1
=
while the other competitor responding with the production
2
2
4
2
s
t s
q

=
. Now , Ior the next iteration, what will be the better choice Ior the competitor 1 (i) to obtain
the proIit
s
t
4
1
=
or (ii) to switch over to Cournot`s reaction Iunction obtaining the proIit
( )
2
2 1
1 sq = where the production oI competitor 2 will be taken
2
2
4
2
s
t s
q

=
as obtained in
490 Elsevier Publications, 2013
An analytic comparison b1etween cournots and stackelberg duopoly theory
Stackelberg`s equilibria, which aIter substituting yields the proIit Ior the Iirst Iirm as
2
1
2
2
1
1

=
s
t
which is considerably higher than the proIit
s
t
4
1
=
unless s t , but we see
that the condition
( )
s
t
sq
4
1
2
2
>
is not suitable because it never holds.
To overcome this, we need a weighting Iactor to be included in this equation. Denoting this weighting Iactor by a
, one gets,
( )
s
t
a sq
4
1
2
2

. . . (20)
and
( )
t
s
a tq
4
1
2
1

. . . (21)
which shows that both the competitors can attempt the Stackelberg`s leadership and above mentioned are two
conditions also called the jump conditions one Ior each competitor to stick to Cournot reaction Iunctions.
As mentioned earlier in (6) and (7), now we speciIy the production oI both the Iirms which can accommodate
both Cournot equilibrium and Stackelberg equilibrium as Iollows
( )
( )

>
<

=
s
q
s
t
a sq
s
q
s
t
s
t
a sq
s
q q
s
q
q
1
; 0
4
1 &
1
;
4
4
1 &
1
;
2
2
2 2
2
2
2 2 2
2
1
( )
( )

>
<

=
t
q
t
s
a tq
t
q
t
s
t
s
a tq
t
q q
t
q
q
1
, 0
4
1 &
1
;
4
4
1 &
1
;
1
2
1 1
2
2
1 1 1
1
2
5. Comparison
The Stackelberg model is amongst the most Irequently applied models oI oligopolistic interaction. In Duopoly, it
reIers to situation in which one Iirm, the Stackelberg leader, can commit to its output Iirst. A sequential order oI
move is today`s interpretation oI Stackelberg model. Stackelberg`s original idea was a behavioral diIIerence
between the Iirms .The Stackelberg Iollower is a Iirm which reacts according to the Cournot best reply logic. The
Stackelberg leader realizes this and takes advantage oI the adaptive behaviour oI the Iollower. Actual markets
491 Elsevier Publications, 2013
Shivani Sanan , Amanpreet Singh and Amit Mehta
may indeed exhibit such a sequential order oI moves. An important implication oI the Stackelberg model is that it
improves market eIIiciency. Daughety considers a parameterized class oI Stackelberg markets and shows that all
sequential move structures are beneIicial compared to the simultaneous move Cournot markets. Under random
matching, Stackelberg markets yield total quantities which are even higher than theoretically expected, while
Cournot markets match the theoretical predictions very accurately.
6. Conclusion
Concluding the above said discussion, we can say that iI one compares the Stackelberg`s equilibrium with the
Cournot`s equilibrium, the proIits are higher in Stackelberg`s equilibrium but iI the Iirm swithes over to
Cournot`s reaction principle, the proIits become higher in Counot`s dynamic process as compared to
Stackelberg`s equilibrium. So the best choice Ior a single period is to keep to Cournot`s action but in the next
iteration, the proIits become lower than in Stackelberg`s equilibrium so the Iirm controlling leadership will again
try to adopt Stackelberg action.
References
|1|. Agiza, H.N., Elsadany, A.A., 2004. Chaotic dynamics in nonlinear duopoly game with heterogeneous players. Applied
Mathematics & Computation 149, 843-860.
|2|. Cournot, A., 1838. Recherces sur les principes mathematiques de la theorie des richesses, Dunod, Paris.
|3|. Kopel, M., 1996. Simple and complex adjustment dynamics in Cournot duopoly models. Chaos, Solitons & Fractals 7, 2031-
2048.
|4|. Milnor, J., 1985. On the concept oI attractor. Communications in Mathematical Physics 99,177-195.
|5|. Puu, T., 1991. Chaos in duopoly pricing. Chaos, Solitons & Fractals 1, 573-581.
|6|. Puu, T., 1998. The chaotic duopolists revisited. Journal oI Economic behavior & Organization 33, 385-394.
|7|. Puu, T., Sushko, I. (Ed.s), 2002. Oligopoly and Complex Dynamics: Models and Tools. Springer, New York.
|8|. Puu, T. 2009. UniIying Cournot and Stackelberg duopoly in one dynamical system, in C. Chiarella, G.I.Bischi, L. Gardini (Eds.),
Nonlinear Dynamics in Economics and Finance, Springer-Verlag, Berlin 2009.
|9|. Puu, T., 2010. Dynamics oI Stackelberg Duopoly, in T. Puu and A. Panchuk (Eds.), Advances in Nonlinear Economic Dynamics,
Nova Science Inc., New York, 2010.
|10|. Singh A, Sandhu R. PayoII in Oligopoly MarketsA Mathematical Model.Elixir.Appl.Maths.59(2013) 15432-15434
|11|.Von Stackelberg, H., MarktIorm und Gleichgewicht, Julius Springer, Berlin, 1934.
492 Elsevier Publications, 2013
Index

C
Cournot competition, 483486

D
Direct demand function, 482

L
Linear model, 480

N
Non linear duopoly model, 480482
cournot competition, 483486