Cournot Economics

The basic Cournot model of oligopoly can show how product differentiation and market power can affect industry price and output. However, some “ground work” needs to be done before diving into the Cournot model with differentiation. For starters, standardized assumptions can not be used with differentiated products. The standardized assumption is that if firm 1 undercut firm 2’s price, the entire market would shift to firm 1. However, the entire market will not move from one market …

…so will the profit-maximizing price. The higher price will allow firms to produce less, actually firms will naturally produce less, lowering costs of production and increasing profits. The increasing prices and decreasing quantities are caused by product differentiation, which affects a market in a similar way to a monopoly. Taken to the extremes of absolute differentiation, each firm will have created an entirely new market. Furthermore, that firm will have monopoly control of that market.