Cournot Duopoly

The Setup:
Q = q1 + q2 = 14 1/2 P
P = 28 2Q = 28 - 2q1 - 2q2
Cost(q1) = 4q1
Cost(q2) = 4q2
MC1 = MC2 = ATC1 = ATC2 = 4
If This Market Were Monopolistic:
MR = 28 4Q
Set MR = MC
28 4Q = 4
4Q = 24
Q=6
P = 28 2(6) = 16
Profit = Revenue Cost
= PQ 4Q
= (16)(6) 4(6) = 72
If This Market Were Competitive:
Set P = MC
P=4
Q = 14 1/2P
= 14 (4)
Q = 12
We dont know how many firms we have in this market, but we can calculate
profit for the market as a whole:
Profit = PQ 4Q
= (4)(12) 4(12) = 0
If This Market Were a Non-Cooperative Oligopoly (Duopoly):
Each firm will conjecture about what the other firm will do.
Assume that firm 1 conjectures that firm 2 will produce of the monopoly output
(3 units).
Then, inverse demand facing firm one, given the conjecture is:
P = 28 - 2q1 2(3)
= 22 - 2q1
and, therefore, MR = 22 - 4q1
Firm 1 will then find the profit maximizing out put by setting MR = MC.
22 - 4q1 = 4
q1 = 4.5
P = 28 - 2q1 - 2q2
= 28 2(4.5) 2(3) = 13
Profit for firm 1 = 13(4.5) 4(4.5) = 40.5
Profit for firm 2 = 13(3) 4(3) = 27 (firm 2 probably wont be happy)

So, will firm 2 produce 3 units? No, they are going to have a conjecture of their
own.
Suppose firm 2 conjectures that firm 1 will produce 4.5 units
Then, the inverse demand facing firm 2 is:
P = 28 2(4.5) 2q2 = 19 - 2q2
And, therefore, MR = 19 - 4q2
Firm 2 will set MR = MC
19 - 4q2 = 4
q2 = 3.75
P = 28 2(4.5) 2(3.75) = 11.5
Firm 1 profit = (11.5)(4.5) 4(4.5) = 33.75
Firm 2 profit = (11.5)(3.75) 4(3.75) = 28.125
This process of adjustment will continue until each firm is correct in its conjecture
and neither firm has an incentive to re-optimize.
Consider the following table. Assume that firm 1 makes a conjecture about firm 2 (colum
1). Firm 1 will have a best response to that conjecture (column 2). But, given firm 1s
best response, firm 2 will adjust to its best response to firm 1s output (column3)
Firm 1s Conjecture of
Firm 2s Output
3
3.25
3.75
4
4.25
4.5
4.75
5

Firm 1s Best Response to

the Conjecture
4.5
4.375
4.125
4
3.875
3.75
3.625
3.5

Firm 2s Best Response to

Firm 1s Best Response
3.75
3.8125
3.9375
4
4.0625
4.125
4.1875
4.25

As stated previously, the adjustment stops when both firms are correct about their
conjectures and nobody has an incentive to re-optimize (both producing 4).