Stackelberg Model

Like Cournot, there are 2 firms that set quantity

However, game is not simultaneous, it is
sequential
What does this mean?
One firm, the leader, chooses quantity first
The other firm, the follower, observes the leaders
quantity and then chooses quantity
Once the two quantities are chosen, price is set to
clear the market
How do we solve this game?
Work backwards -- use backward induction
Start at the last step -- setting price to clear the
market
P = a - b(q
L
+ q
F
)
Next step before that -- follower chooses quantity
to maximize profit given leaders choice.

F
= (a - b(q
L
+ q
F
) - c) q
F

Take derivative and set = 0 to get BR
a - bq
L
- 2bq
F
- c = 0
q
F
* = (a - bq
L
- c)/2b




Now go the first step -- leader chooses quantity to
maximize profit

L
= (a - b(q
L
+ q
F
) - c) q
L

However, leader knows how follower will respond
-- leader can figure out followers BR, so:

L
= (a - b(q
L
+ (a - bq
L
- c)/2b) - c) q
L
Simplify to get
L
= (a - bq
L
- c)/2 q
L
Take derivative and set equal to 0 to get BR:
(a - 2bq
L
- c)/2 = 0 q
L
= (a - c)/2b
And q
F
*=(a-bq
L
-c)/2b=(a-b(a-c)/2b-c)/2b=(a-c)/4b





Leader has the advantage -- he sets higher quantity
and gets a higher profit than the follower
Often called the first-mover advantage
Total output = (a-c)/2b + (a-c)/4b = 3(a-c)/4b
Greater than total Cournot output of 2(a-c)/3b
So Stackelberg competition not as bad as
Cournot, but firms still make profit.