Extending Cournot: When Does Insight Dissipate?

Abstract

The Cournot model makes assumptions about the knowledge of the players, which can lead to counterintuitive results when extending the basic model. Closed-loop equilibria and models with consistent conjectural variations are problematic in that they reduce or eliminate economic rents while the players have more knowledge than under standard Cournot assumptions. The loss of profit arises because the information is about reactions and not about equilibria, the players do not deduce or carry over relevant information from one stage of the game to the next, and they operate in a reactive decision space rather than reframing the game proactively. We show how the equilibrium changes and profits improve as players enlarge their strategies and point out the problems associated with each improvement in their strategies. However, the equilibrium is dependent on the starting point. Critical to modeling oligopolies is identifying the knowledge levels and the decision spaces of the players. Our conclusion is that, although the basic Cournot model provides insights into oligopolies, extensions that rely on the Cournot assumption that the other player does not react are probably mathematical artifacts that do not contribute to understanding how markets operate. Oligopoly theory should focus more on alternative descriptions of players' knowledge and their strategic alternatives, especially on how the players frame the behavior of others in their industries, rather than rely on a few standard equilibria. This makes the case for an agent-based approach.