This video will build off of the market equilibrium and consumer and producer surplus videos. If you aren't familiar with those topics already, you should watch those videos first. For those of you still here, let's get started.
In economics, students will learn early on about the perfect competition situation. This is where a market reaches an efficient outcome, where quantity supplied and quantity demanded are equal, and there is no deadweight loss. But what about other situations besides perfect competition?
Today we will introduce three more common market situations. These are Bertrand, Corno, and Stackelberg competition. First, Bertrand competition is the most straightforward of these.
In this type of competition, there could be any number of firms competing, and they compete by setting prices. All firms choose the price that they will sell their output at, and they choose at the same time. In this model, we assume that the goods are perfect substitutes and that firms have the same costs.
So each firm wants to set its price at the same monopoly price to maximize its profits. But there's a catch. If even one firm sets its price slightly below the monopoly price, it will suddenly capture all of the market share since buyers will flock to the cheapest price.
Remember, these goods are perfect substitutes. Therefore, all of the other firms will fail to sell at all and will make losses, while the one firm that undercut will make slightly less than monopoly profits, but they will still make a profit. So, before making their pricing decisions, the firms know this. So they all expect that they will be undercut if they don't set their price at marginal costs. Therefore, every firm sets their price equal to marginal costs, which is the same outcome as in perfect competition.
We just get there in a different way. Second, Cournot competition is the second type of competition we'll look at today. In Cournot competition, a number of firms compete in quantity instead of in prices.
Like in Bertrand competition, the Cournot model also assumes that products are perfect substitutes and that each firm makes its decisions at the same time. Here the main difference is that the firm's decision is the quantity to produce, not the price to sell at. The Cournot model assumes that prices are set by the market, not by firms. Each firm, again, would like to produce the monopoly quantity and receive the monopoly price. But if every firm produces the monopoly quantity, The price will end up being very low since the quantity supplied is quite high in this case.
Demand would then be split between all of the firms since they have the same quantity and price and identical products. And so in this case, all the firms would be left with excess inventory and probably some losses. So rather than do this, each firm anticipates that the others will do the best they can to react to their decisions.
This ends up leading the firms to collectively produce a quantity higher than the monopoly quantity, but lower than in a comparison. perfectly competitive equilibrium. The prices will also be higher than in perfect competition, but lower than they would be in a monopoly. You might wonder why firms don't just collectively produce the monopoly quantity and each receive the monopoly price for part of that total quantity.
This is a real situation known as a cartel. But a cartel does not have a stable equilibrium, because each member of the cartel would be better off if they produced a few extra units. Doing this would lower the market price for everyone slightly, but the firm that made the extra units would still get a fairly large profit from them. This shifts the market from the cartel solution to the Cournot solution.
Therefore, cartels need rules to continue the cartel and prevent the Cournot solution, but this can be difficult in practice. Third and finally, Stackelberg competition is the last one we'll talk about today. Stackelberg is just like Cournot competition. Identical products that are perfect substitutes, firms choose quantities to produce, and the price is set by the market.
However, the difference is that firms choose their quantities in order and not at the same time. The first firm to choose a production quantity has an advantage and can capture more market share. We call this a first mover advantage in economics. And the firm that gets it is called the leader. The other firms are considered followers and are left over with the smaller part of the market share.
However, the leader can't just produce the monopoly quantity because the follower can still produce just a few units, lowering the market price slightly. but getting a positive profit. If the follower does this, it causes the leader's choice of monopoly quantity to be suboptimal.
Anticipating this behavior by the follower, the leader chooses a quantity smaller than monopoly quantity, but still larger than what they would produce in a Cournot equilibrium. The follower, meanwhile, produces slightly less than they would in the Cournot equilibrium. The final outcome in Stackelberg competition is a market that is more competitive than in the Cournot situation, but still not perfectly competitive.
Prices are higher than in perfect competition, but lower than in the Cournot equilibrium, and the quantity produced is higher than in Cournot equilibrium, but lower than in perfect competition. Okay, that was a lot of information. If you want to do a more detailed dive into any of these terms, check out their articles in the Economics Terms A-Z section on Inomics. you'll benefit from the ready-made listed plans, handouts, and assessments in each pack.
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