1. Stackelberg and Bertrand Kevin Hinde

2. The Dominant Firm - Quantity Leadership Heinrich von Stackelberg (1934) F Stackelberg’s duopoly model assumed that one firm acts as a dominant firm in setting quantities. F Dominance implies knowledge of the way competitors will react to any given output set by the leading firm (in the Cournot model neither firm had the opportunity to react). F A dominant firm can then select that output which yields the maximum profit for itself.

3. numerical example revisited Assume market demand to be P = 30 - Q where Q= Q1 + Q2 ie industry output constitutes firm 1 and firm 2’s output respectively Further, assume Q1 = Q2 and average (AC) and marginal cost (MC) AC = MC= 12

4. Assume Firm 1 is the dominant firm and has has prior knowledge of Firm 2s reaction curve. F Total Revenue for Firm 1 is as under Cournot F R1= 30Q1 - Q1 2 - Q1Q2 F But Firm 1 knows Firm 1s reaction curve so F R1= 30.Q1 - Q1 2 - Q1.( 9 - 1 Q1) F 2 F R1= 21.Q1 -1 Q1 2 F 2 F Thus, F MR1= 21 - Q1

5. F which when equated with MC (=12) to find Firm 1s equilibrium output gives F 12= 21 - Q1 F Q1= 9 F Q2= 9 -1 Q1= 4.5 2 F P= 30 - Q F P=16.5

6. F Thus, we can see that in a duopoly framework Stackelberg assumptions offer better welfare outcomes than Cournot. Questions –Can you position the Stackelberg equilibrium on a reaction curve diagram and contrast with Cournot? –What levels of abnormal profit do you associate with each equilibrium position? –What would happen to the Cournot and Stackelberg equilibria if the marginal cost of Firm 1 was 10 whilst Firm 2’s MC remained unchanged?

8. Joseph Bertrand (1883) F Bertrand argued that a major problem with the Cournot model is that it failed to make price explicit. F He showed that if firms compete on price when goods are homogenous, at least in consumer’s eyes, then a price war will develop such that price approaches marginal cost. F However, the introduction of differentiation leads to equilibrium closer in spirit to Cournot.

9. Product Differentiation Collusive Equilibrium Ppc Pm P1 P2 P2= f(P1) P1= f(P2)