Cournot theory of duopoly
- Let’s imagine that the firms are Samsung and LG and that the product is DRAM chips.
- Suppose that Samsung’s and LG’s DRAMs are identical and that their marginal costs are also identical, so both firms will charge the same price.
- The only decision each firm needs to make is how much to produce.
- The firms select their output simultaneously, noncooperatively (without colluding with each other), and with no knowledge of each other’s plans (without spying on each other).
- Once both firms select their output, the market price instantly adjusts to clear the market. That is, given the firms’ output choices, the market price becomes the price at which consumers are willing to buy the firms’ combined output.
- Each firm’s output choice depends on the market price, but the market price depends on the combined output of the two firms (i.e., the market price isn’t known until both firms have made their output choice).
- Therefore, each firm will make the output choice that maximizes its profit based on its expectation of the other firm’s output choice.
- Thus, Samsung will choose the level of production that maximizes its profits, given what it thinks LG’s output will be, and LG will choose the level of production that maximizes its profit, given what output it thinks Samsung will produce.