The Cournot Duopoly Model is a generalization that describes industry structures when more than one firm (having considerable market power) interacts and competes in the same market. The model assumes that if two rival firms producing a homogenous product with the same cost functions (usually treated as common knowledge) split a market, the firms will respond to each other’s output production until a state of equilibrium is reached. The model predicts that the firms will choose the level of output going towards equilibrium.
If two firms produce a certain good, the profit gained is a decreasing function of the total number of goods that the two firms produce. Both firms are aware that price is a decreasing function of total output; thus, each firms takes the given output of the other in order to secure optimum profit. How one firm determines its production output and prices is directly affected by its rival’s decisions—if one firm increases its output or prices, the other firm changes its output and prices to match it.
Each firm attempts to maximize profits by taking into account the output or price decisions of the other firm. Eventually, both firms will have an equal market share where there are no incentives for changing output decision, and will accrue only normal profits. The output will be greater than that of monopoly, but less than that of a perfect competition, and the cost of goods will be lower than that of monopoly, but not much lower than that of a perfect competition.
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