In an oligopoly, there are a number of firms which are all large enough to have an effect on price. Participants therefore analyse their competitors expected reaction to a change in output or price in order to make a profit maximizing decision. This is unlike for example, a competitive market, where results depend only on a firms own actions. Hence, a firm must know how their competitors will react to changes in price or quantity if they wish to find the optimum levels of output and price.
In this essay, I will assume that there are only two firms in the market, this situation is known as a duopoly. I will also assume that both of these firms produce a homogenous product, so that I can ignore the factors of product differentiation and the associated brand loyalty.
Having removed the complications of product differentiation and multiple firms, we are left with the factors of output and price as the methods of competition in an oligopoly.
English: Short-run equilibrium of the firm under m...
English: profit maximizing firm
English: If a Firm may have a Monopoly (no Competi...This essay will specifically examine the strategic issue of changing the levels of output. There are two different models to study which involve the setting of output: The Stackelberg model, where one firm makes a choice before the other firm and becomes a "quantity leader", and the Cournot model, where there is "simultaneous quantity setting" because when one firm sets it's output it doesn't know what the competitors reaction will be.
There is one more form of interaction between firms in an oligopoly, by which firms jointly set price and quantity to maximize their profits. This is known as collusion. I will firstly examine the two models in which firms compete by setting output and then deduce why non-collusion is the inevitable outcome.
If firms are simultaneously deciding what quantity to produce, they must...