Duopoly Models

Suppose duopolists produce quantities of given differentiated

products (x1 , x2 ). Assume the marginal costs of each unit of output are
constant and equal for both firms, i.e., MC(x1 ) = MC(x2 ) = k. Also assume
neither firm has any fixed costs. The price each firm obtains depends on
the quantities of output by each (or, alternatively the quantity demanded for
each firm depends on the price each firm charges), according to the
inverse demand functions:

p 1 = A − x 1 − bx 2 p 2 = A − x 2 − bx 1

for constants A and b. The constant b is restricted to the interval (-1, +1),
where b > 0 means that the goods in question are "substitutes" and b < 0
means they are "complements."

The profit of firm i is given by:

o i = p i x i − C (x i ) = (A − x i − bx j )x i − kx i = (A − k)x i − x 2i − bx i x j

Given particular values: A = 10 and k = 1:

o i = 9x i − x 2i − bx i x j

Given the Cournot assumption, we treat xj as a constant and obtain the

following first-order condition for a maximization of profit for firm i:
do i
dx i = 9 − 2x i − bx j = 0

Which gives the reaction function:

9−bx j
x &i = 2
Let’s assume the parameter b = − 34 . Then the payoff matrix of profits is
given by:

Profit Firm
Matrix 2’s
Output
(π ι , π 2 ) x2
5.5 7.2 7.73 8.61 11.25 18
5.5 (41.9, 41.9) (49.0,42.7) (51.1, 41.7) (54.8, 38.9)

7.2 (42.7, 49.0) (51.8, 51.8) (54.7, 51.6) (59.5, 49.9)

Firm 1’s
Output -
x1
7.73 (41.7, 51.1) (51.6, 54.7) (54.6, 54.6) (59.7, 53.3)

8.61 (38.9, 54.8) (49.9, 59.5) (53.3, 59.7) (59.0, 59.0)

11.25 (69.6, 69.6) (126.6, -10.1)

18 (-10.1, 126.6) (81,81)

Nash-Cournot equilibrium is at output pair (7.2,7.2)

von Stakelberg equilibrium is at output pair (8.61,7.73)
Joint-Profit maximization occurs at output pair (11.25,11.25) not stable
Bertrand Price Competition results in price pair (6.73,6.73) output pair would be (13.09,13.09)
Econ 253 Intermediate Microeconomics Spring 03

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Duopoly Examples: b  
4
Cournot Equilibria

x2p π1 x1 b  root  9  x1  x1  b  x1  x2  π1 x2

2
Isoprofit Curves for Firm 1:  

9  b  x1 9  2  x1
Reaction Functions: 
x2r x1 b   2

x1r x1 b   b

Cournot Equilibrium [b = -0.75]

7.2


x2p 53.2663 x1 b  7.2
x2p 51.84 x1 b 7
Output of Firm 2

x2p 50 x1 b 

x2r x1 b

x1r x1 b
6

6.4 6.6 6.8 7 7.2 7.4 7.6

x1
Output of Firm 1

9  b  x2 9  b  x1  7.2 
Given x1 =
2
x2 =
2

Find x1 x2    
 7.2 

 
p1 x1 x2 b  10  x1  b  x2  
p2 x1 x2 b  10  x2  b  x1


p1 x1 x2 b  8.2  
p2 x2 x2 b  8.2 
2
 
π1 x1 x2 b  9  x1  x1  b  x1  x2 π1 ( 7.2 7.2 b)  51.84

2
 
π2 x1 x2 b  9  x2  x2  b  x1  x2 π2 ( 7.2 7.2 b)  51.84

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Duopoly Examples: b  
4
von Stackelberg Equilibria with Firm 1 as Leader

x2p π1 x1 b  root  9  x1  x1  b  x1  x2  π1 x2

2
Isoprofit Curves for Firm 1:  
9  b  x1 9  4.5  b
Reaction Function 
x2r x1 b   2
Leader's output: x1r ( b) 
2
for Firm 2:: 2b
x1r ( b)  8.61

von Stakelberg Equilibrium [b = -0.75]

7.8
7.2 8.6087
7.7283

7.6


x2p 53.2663 x1 b 
Output of Firm 2

7.4
x2p 51.84 x1 b

x2p 50 x1 b 

x2r x1 b 7.2 7.2

6.8
7 7.5 8 8.5 9
x1
Output of Firm 1

9  b  x1
x1  8.6087 x2  x2  7.73
2
 
p1 x1 x2 b  10  x1  b  x2  
p2 x1 x2 b  10  x2  b  x1


p1 x1 x2 b  7.19   
p2 x1 x2 b  8.73

2
 
π1 x1 x2 b  9  x1  x1  b  x1  x2  
π1 x1 x2 b  53.27

2
 
π2 x1 x2 b  9  x2  x2  b  x1  x2  
π2 x1 x2 b  59.73

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Duopoly Examples: b  
4
Joint Profit Maximization:

x2p π1 x1 b  root  9  x1  x1  b  x1  x2  π1 x2

2
Isoprofit Curves for Firm 1:  

Joint Profit Equation:    

π x1 x2 b  π1 x1 x2 b  π2 x1 x2 b  
d d  18 
Given  
π x1 x2 b = 0 
π x1 x2 b = 0  
Find x1 x2   
dx1 dx2  18 

9  b  x1 9  2  x1
Reaction Functions: 
x2r x1 b   2

x1r x1 b   b

Joint Profit Maximization [b = -0.75]

50
7.2 11.25

40


x2p 126.5625 x1 b 
x2p 81 x1 b 
Output of Firm 2

30
x2p 69.6094 x1 b 

x2r x1 b
20
18
x1r x1 b

10
7.2

5 10 15 20
x1
Output of Firm 1

p1 x1 x2 b  5.5  
π1 x1 x2 b  81 

p2 x1 x2 b  5.5  
π2 x1 x2 b  81 
9  b  18
x1  x1  11.25 π1 ( 11.25 18 b)  126.56 π2 ( 11.25 18 b)  10.13
2

π1 ( 11.25 11.25 b)  69.61 π2 ( 11.25 11.25 b)  69.61

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Duopoly Examples: b  0.75

Bertrand Price Competition

Isoprofit Curves for Firm 1:  10  p1  10  b  b  p2 

  
p2i π1 p1 b  root  p1  1    π1 p2
 1b
2 

Reaction Functions: 11  10  b  b  p1 2  p1  11  10  b

p2r p1 b   2
 
p1r p1 b 
b

Bertrand Equilibrium Solution [When b = -0.75]:

Bertrand Equilibrium [b = -0.75]

12
6.7273

10
 
p2i 81 p 1 b

p2i 74.9749 p 1 b

Price for Firm 2

8
p2i 51.84 p1 b 
6.7273
p1r p 1 b 6

p2r p 1 b

2
5 6 7 8
p1
Price for Firm 1

11  10  b  b  p2 11  10  b  b  p1  6.73 
Given p1 =
2
p2 =
2

Find p1 p2    
 6.73 
10  ( 1  b)  b  p1  p2
x1  x1  13.09
2
1b

10  ( 1  b)  b  p2  p1
x2  x2  13.09
2
1b

10  ( 1  b)  b  p1  p2
π1  p1  1    2
π1  74.97
1b

10  ( 1  b)  b  p2  p1
π2  p2  1    2
π2  74.97
1b

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