CHAPTER 12 • Monopolistic Competition and Oligopoly 463 Figure 12.5 If the firms agree to share profits equally, each will produce half of the total output: Q1 = Q2 = 7.5 As you would expect, both firms now produce less—and earn higher profits (112.50)—than in the Cournot equilibrium Figure 12.5 shows this collusive equilibrium and the competitive output levels found by setting price equal to marginal cost (You can verify that they are Q1 = Q2 = 15, which implies that each firm makes zero profit.) Note that the Cournot outcome is much better (for the firms) than perfect competition, but not as good as the outcome from collusion First Mover Advantage—The Stackelberg Model We have assumed that our two duopolists make their output decisions at the same time Now let’s see what happens if one of the firms can set its output first There are two questions of interest First, is it advantageous to go first? Second, how much will each firm produce? Continuing with our example, we assume that both firms have zero marginal cost, and that market demand is given by P = 30 − Q, where Q is total output Suppose Firm sets its output first and then Firm 2, after observing Firm 1’s output, makes its output decision In setting output, Firm must therefore consider how Firm will react This Stackelberg model of duopoly is different from the Cournot model, in which neither firm has any opportunity to react Let’s begin with Firm Because it makes its output decision after Firm 1, it takes Firm 1’s output as fixed Therefore, Firm 2’s profit-maximizing output is given by its Cournot reaction curve, which we derived above as equation (12.2): Firm 2=s reaction curve: Q2 = 15 - Q (12.2) What about Firm 1? To maximize profit, it chooses Q1 so that its marginal revenue equals its marginal cost of zero Recall that Firm 1’s revenue is R = PQ1 = 30Q1 - Q 21 - Q2Q1 (12.3) Because R1 depends on Q2, Firm must anticipate how much Firm will produce Firm knows, however, that Firm will choose Q2 according to the reaction curve (12.2) Substituting equation (12.2) for Q2 into equation (12.3), we find that Firm 1’s revenue is R1 = 30Q1 - Q21 - Q1 a 15 = 15Q1 - Q b 1 Q Its marginal revenue is therefore MR = ⌬R 1/⌬Q1 = 15 - Q1 (12.4) • Stackelberg model Oligopoly model in which one firm sets its output before other firms