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3.3. Stackelberg Model: Matilde Machado Slides Available From
3.3. Stackelberg Model: Matilde Machado Slides Available From
Stackelberg Model
Matilde Machado
Slides available from:
http://www.eco.uc3m.es/OI-I-MEI/
1
3.3. Stackelberg Model
Important Questions:
1. Is there any advantage in being the first to
choose?
2. How does the Stackelberg equilibrium
compare with the Cournot?
given
Industrial Organization- Matilde Machado Stackelberg Model 4
2
3.3. Stackelberg Model
Max Π 2 = ( P ( q1 + q2 ) − c ) q2 = ( a − b(q1 + q2 ) − c ) q2
q2
∂Π 2
FOC: = 0 ⇔ a − 2bq2 − bq1 − c = 0
∂q2
a − bq1 − c
⇔ q2* = R2 (q1 ) = = Cournot's reaction function
2b
∂Π1
FOC: = 0 ⇔ a − 2bq1 − bR2 (q1 ) − bq1 R2′ (q1 ) − c = 0
∂q1
a − bq1 − c 1
⇔ a − 2bq1 − b + bq1 − c = 0
2b 2
a −c 1 1
⇔ − 2bq1 + bq1 + bq1 = 0
2 2 2
a −c a −c 3 N a−c
⇔ − bq1 = 0 ⇔ q1 =
*
= q1 > q1N =
2 2b 2 3b
3
3.3. Stackelberg Model
*
Given q1 we solve for q2
a −c 1 * a −c 1 a −c a−c 3 N
q2* = − q1 = − = = q2 < q2
N
2b 2 2b 2 2b 4b 4
Therefore q1* > q2*
a − c a − c 3( a − c) 2 ( a − c)
q1* + q2* = + = > = QN
2b 4b 4b 3b
a>c
3 ( a − c ) a + 3c
p = a − bQ = a − b
* *
= >c
4b 4
a + 2c
But p* < = pN
3
4
3.3. Stackelberg Model
Conclusion:
a) q1* > q2* (the leader produces more)
b) p* > c (There will be a DWL)
c) Π1* > Π 2* (the leader has higher profits, there is an advantage of being the first to choose)
d) Q* > Q N ⇒ p* < p N
The leader has a higher profit for two reasons: 1) the leader knows that by
increasing q1 the follower will reduce q2 (strategic substitutes). 2) the
decision is irreversible (otherwise the leader would undo its choice and we
would end up in Cournot again)
Π1 ( q1 , q2 ) = ( a − b( q1 + q2 ) − c ) q1
therefore:
π = ( a − b( q1 + q2 ) − c ) q1 = aq1 − bq12 − bq1q2 − cq1
⇔ bq1q2 = ( a − c ) q1 − bq12 − π
⇔ q2 =
(a − c) − q − π
1
b q1
∂q2 π ∂ q2 2π 2
= −1 + 2 ; =− 3 <0
∂q1 q1 ∂q12 q1
5
3.3. Stackelberg Model
Graphically(cont):
q2 Given q2, firm 1 chooses its best
response i.e. the isoprofit curve that
corresponds to the maximum profit
given q2
π’<πM=(1/b)((a-c)/2)^2
Isoprofit = πM =1
single point
q’ qM q’’ q1
6
3.3. Stackelberg Model
Graphically(cont): the optimum of the leader (firm 1) is in a
tangency point (S) of the isoprofit curve with the
q2 reaction curve of the follower (firm 2). (C) would be
the Cournot equilibrium, where the reaction curves
cross and where dq2/dq1=0
q1S>q1N
qM
C q2S<q2N
S
qM q1
q1S+q2S>q1N+q2N
qM
C
S
-1
qM q1
7
3.3. Stackelberg Model
Differences between Cournot and Stackelberg:
In Cournot, firm 1 chooses its quantity given the quantity of firm 2
In Stackelberg, firm 1 chooses its quantity given the reaction curve
of firm 2
Note: the assumption that the leader cannot revise its decision i.e.
that q1 is irreversible is crucial here in the derivation of the
Stackelberg equilibrium. The reason is that at the end of period 2,
after firm 2 has decided on q2, firm 1 would like to change its
decision and produce the best response to q1, R1(q2). This
flexibility, however, would hurt firm 1 since firm 2 would anticipate
this reaction and the result could be no other but Cournot. This is a
paradox since firm1 is better off if we reduce its alternatives.
Is it plausible to think that q1 cannot be changed? This seems more
plausible for the case of capacities than for the case of quantities.