Cournot Oligopoly and Competitive Behaviour

Author(s): R. J. Ruffin
Source: The Review of Economic Studies, Vol. 38, No. 4 (Oct., 1971), pp. 493-502
Published by: Oxford University Press
Stable URL: https://www.jstor.org/stable/2296692
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 Cournot Oligopoly and
Competitive Behaviour"2
R. J. RUFFIN
University of Iowa

I. INTRODUCTION

The literature on Cournot oligopoly has been concerned with three main issues:'
whether the model is quasi-competitive, i.e., industry output rises and price falls with
additional firms [1], [4], [8]; whether the model converges to perfect competition with an
" infinite " number of firms [2], [4], [7], [8], [10], [12]; and, finally, whether the equilibrium
solution itself is dynamically stable [6], [9], [11]. These issues are interrelated, as the
conditions for quasi-competitiveness and stability are the same,4 and quasi-competitiveness
would seem to be necessary for convergence to the competitive solution. The interrelation-
ship would be complete if quasi-competitiveness were sufficient for convergence. C. R.
Frank [4] has attempted a proof of sufficiency; and, moreover, it is widely believed that
Cournot oligopoly generates perfect competition as an extreme, limiting case [2], [4], [7],
[10], [12]. Indeed, only M. McManus ([8], p. 71 n) has explicitly questioned the converg-
ence to perfect competition.
This paper shows that the Cournot oligopoly model need not converge to perfect
competition, regardless of the quasi-competitiveness of the model. Convergence takes
place if, and only if, there are no scale economies. Without convergence, interest centres
on the other properties of the Cournot model! It is shown, for example, that both quasi-
competitiveness and stability may break down with large numbers of firms. But an example
suggests that the numbers involved, though not impossible, might be higher than one could
expect in practice.
Throughout the analysis we examine the strong case in which all firms are identical.
This strips away the non-essentials and considerably simplifies the analysis. Section II
describes the model and demonstrates the uniqueness of the solution. Section III is devoted
to the limiting behaviour of the Cournot model. Section IV examines the quasi-competitive-
ness and stability of the model. Section V offers an illustrative and suggestive example
based on a general linear demand function and a general cubic cost function. Finally,
Section VI makes some concluding remarks on the relation between numbers of firms and
competitive behaviour.

II. THE MODEL

We use the following definitions:

D. 1. xi is the output of the ith firm.

D.2. Q is industry output.

I First version received May 1969; final version received Dec. 1970 (Eds.).
2 The author is deeply indebted to Christopher Bliss and two anonymous referees for their searching
comments on a previous draft of this paper. I am also grateful to William Brock, Duane Leigh, Cliff
Lloyd, and (especially) S. Y. Wu for helpful discussions of several points.
3 There are, of course, the usual issues of existence, uniqueness, and relevance; and they also will be
discussed.
4 See Frank [4] and Hahn [6], or Section IV below.
493

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494 REVIEW OF ECONOMIC STUDIES

D.3. Qi = Q-xi.
D.4. P is the price of the output.

D.5. N is the number of firms.

D.6. N* is the number of firms that would prevail in long-run competitive equilibrium
given that cost curves are U-shaped.

D.7. Nm is the maximum number of Cournot oligopolists consistent with non-negative

profits.

D.8. N is the output-maximizing number of firms.

Before stating the assumptions we should observe that the Cournot model has not yet
been thoroughly axiomatized, so that the conditions for the existence of a profitable or
viable Cournot equilibrium are uncertain.1 Frank and Quandt [5] have given a proof of
the existence of a Cournot equilibrium, and their conditions are satisfied by the following
assumptions. Unfortunately they failed to address themselves to the survival problem.
Thus we shall tentatively assume that for any N a viable Cournot equilibrium exists. This
assumption will be dropped subsequently. The remaining assumptions are:

A. 1. The (inverse) demand function P = f(Q) is twice differentiable, andf' is negative

and bounded from below.

A.2. The cost function for the ith firm Ci = Ci(xi) is twice differentiable, monotonicall
increasing, and CQ(O) = 0.
A.3. All firms have identical cost functions, i.e., for any x

CQ(x) = C(x) for all i.

A.4. Demand is bounded so that there exists a K such that if Q _ K, f(Q) = 0.

A.5. The profit function for the ith firm (i = I ..., N),

7ri = xif(Q) - C(Xi) = xif(Qi + xi) -xi),

is strictly concave in xi for any Qi, i.e.,

d27ri/dx2 = xif" + 2f'-C" <O. ... (1)

A.6. Each firm maximizes profit on the assumption that Qi is fixe

dni = Xif'+f-C' = O i = 1, ..., N. ...(2)

dxi
A.7. Marginal revenue facing the ith firm is steeper than the demand function, i.e.,

xJf"+f' <0. ... (3)

A Cournot equilibrium is said to p
is producing its optimal output. Accordingly, any solution to equations (2) is a Cournot
equilibrium. Since each firm is identical, it is clear that there exists a symmetrical equili-
brium in which all the xi's are equal. (The reader who is willing to accept the fact that we
need only be interested in the symmetrical equilibrium may skip the next three sentences.)
Iff'- C" = 0, then, under the assumptions, it must be true that x1 = ... = XN.2 Moreover,
as will be seen below, this solution will be unique. Iff'- C" = 0, the size distribution of
1 This ignores the case of constant unit costs. If there are demand prices that exceed unit costs, then
for any price above unit cost, any number of firms can be accommodated.
2 To show this, suppose that there is a Cournot equilibrium consisting of a certain vector of firm
outputs. Consider the reaction curves of any pair of firms given the output of the remaining firms. Then
under the assumptions and f '- C" # 0, the two reaction curves intersect only on the 450 line. Since this
must hold for all pairs of firms, each firm must produce the same output.

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 RUFFIN COURNOT OLIGOPOLY 495

firms may be indeterminate' but, in any case, the

and since our primary interest is in industry output, it is only necessary to look at the
symmetrical solution. It follows that in the equilibrium solution we may drop the subscripts
on the xi's and write x for the output of each firm. The Cournot model then can be written
in the following convenient form:

xf'() +f(Q) - C'(x) = 0, ... (4)

Q = xN. ...(5)
Equations (4) and (5) give us a system of two equations in two unknowns, and, if the
conditions of the implicit function theorem are satisfied, there exist functions Q = Q(N)
and x = x(N), which gives uniqueness for Q. The implicit function theorem requires that
the Jacobian of (4)-(5) be non-vanishing.

Lemma. Under A.1 through A.7, the Jacobian of (4)-(5) is positive.

Proof. Partially differentiate (4)-(5) with respect to Q and x, obtaining

J(Q,x) f 1x+f f--C" = -(xf"+2f'-C")-(N-1)(xf"+f').

I -N

Clearly, from the second-order condition, (1), and the marginal revenue condition, (3),
J(Q, x) is positive.

The second-order condition cannot be avoided; however, the marginal revenue

condition, (3), may be questioned. To establish its reasonableness, recall that the condition
states that marginal revenue to thefirm declines faster than price (as can be seen by adding
f' to both sides). This is consistent with marginal revenue to the industry falling slower
than price, remaining constant, or even rising. Suppose, to take a simple case, that
p = Qula, where a is the elasticity of demand. Then

Xf"+ft = Q(l-a)la[(1 -a)lNa2+ 1la]. ...(6)

This will be negative if N exceeds 1 - 1/a. Thus, for example, if the elasticity of demand,
a, equals -1, then N must exceed 2. Since we are working with Cournot oligopoly,
condition (3) therefore seems reasonable.

III. COURNOT OLIGOPOLY: LIMITING BEHAVIOUR

Let us now turn to the widespread belief that the Cournot model converges to the
competitive solution as N tends to infinity. Obviously, this convergence will not happen
if, while N is rising, the oligopoly becomes unworkable. This can happen in three ways:
the model can lose its viability, sensibility, or stability. Cournot oligopoly is not viable
if, as more firms enter, profits fall below zero; it is not sensible if, as more firms enter, th
second-order condition for profit-maximization is violated; or it may not be stable if more
firms lead to the violation of important group stability conditions (see below). But con-
vergence to perfect competition is not guaranteed even if none of the above things happens.
This is easily shown. Since Q is bounded by A.4, and x = QIN, it is clear that as N
tends to infinity, x tends to zero. Now average costs are defined by A(x) = C(x)/x. Thus
A(x) is the ratio of two functions which each tend to zero (by A.2, C(0) = 0) as x tends to
zero; accordingly, we may apply L'Hospital's rule,
lim A(x) = lim C'(x)/1 = C'(0). ...(7)
x-O x-O

1 To show that the size distributio

cal solution to (2), where
xi x. No
It is then easy to show that the ma
hold provided C" is constant over t
be unique.

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496 REVIEW OF ECONOMIC STUDIES

Thus from (2) and A.1 it follows that

lim P = lim (C'-xf') = C'(O). ... (8)

N- oo N- oo
x-O x-O

In the limit, the Cournot equilibrium price approaches marginal and average costs where
x = 0.
To establish convergence to perfect competition, it would have to be shown that the
limiting marginal cost is the same as marginal cost under perfect competition.' It is well
known, however, that in competitive equilibrium (long-run), marginal cost = min A(x).
Thus, Cournot oligopoly converges to competitive equilibrium if and only if

C'(0) = min A(x).

Hence, we may state the following theorems:

Theorem 1. If A(x) is non-decreasing, so that C'(O) = min A(x), the Cournot solution
tends to the competitive solution as N tends to infinity.

Theorem 2. If A(x) is U-shaped, so that C'(0) exceeds min A(x), the Cournot solution
does not tend to the competitive solution as N tends to infinity, and the limiting Cournot pric
exceeds the competitive price.

The above results are easily explained. The basis for the belief that Cournot oligopoly
tends to perfect competition is the notion that under perfect competition there are so many
firms that no single firm can perceptibly influence price. It is true that as more firms enter
an industry and each firm produces a diminishing share of market output, the elasticity of
demand facing the firm would eventually tend to infinity. But the effect of additional
output on price depends on the slope of the market demand curve, not elasticity. The
number of firms is irrelevant, except insofar as it influences the position on the market
demand curve. Thus for a Cournot oligopolist, who knows the market demand curve,
marginal revenue is still below price. Accordingly, the firm can be in equilibrium even if
marginal costs are falling and the firm's perceived elasticity is infinity (e.g., see McManus
[8], p. 71). This would be the precise situation of a Cournot oligopolist in the limiting
case involved in Theorem 2-the firm would be extremely small and necessarily producing
on the downward-sloping side of the U-shaped cost curve.

IV. QUASI-COMPETITIVENESS AND STABILITY

The behaviour of the Cournot output function Q = Q(N) for marginal changes in N
has been investigated by Frank [4] and McManus [8].2 In this section, their work is restated
in a more compact form, some global properties of the output function are established, and
the connection with dynamic stability (following Hahn [6]) is noted.
From the lemma in Section II we are assured of the existence of functions Q = Q(N)
and x = x(N). It is convenient, but not necessary, to treat N as a continuous variable
(e.g., see Baumol [1]). The signs of dQ/dN and dx/dN can be determined then by totally
differentiating (4)-(5), yielding

[xf"+f fX-C" [dQldN] [F (90

I -N ILdxidNJ[= xJ'

1 The failure of the proofs of convergence offered by Frank [4] and Vickery ([12],
stopped short of this observation and relied on something similar to equation (8).
2 Baumol [1] has conjectured that the output function need not increase with N if the demand function
is non-linear. The work of Frank and McManus shows that the non-linearity of the demand function
does not matter provided the marginal revenue condition (A.7) is satisfied.

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 RUFFIN COURNOT OLIGOPOLY 497

Solving by Cramer's rule gives

dQ/dN = - x(f' -C")ID .. .(1o)
dx/dN = x(xf" +f')/D, ...(11)

where D is the Jacobian determinant of the matrix of coefficients. Since D is positive

(lemma), the following theorems are established:
Theorem 3. Given A. 1 through A.7, dQ/dN is positive, zero, or negative as f'- C" is
negative, zero, or positive.

Theorem 4. Given A. 1 through A.7, dx/dN is negative.

To show that D is positive it was necessary to assume that xf" +f' <0; this condition,
together withf'- C" < 0, form the critical pair of conditions for determining that dQ/dN> 0.
These are the conditions used by Hahn [6] for establishing the dynamic stability of a Cournot
equilibrium.
Theorems 3 and 4 summarize the work of Frank [4] and McManus [8], though they
treated N as a discrete variable. The next theorem that we want to establish is that if
Q = Q(N) has a relative maximum, that maximum is global. This means that for discrete
N, no more than two maxima are possible. From Theorem 3 it is clear that if marginal
costs are non-decreasing, dQ/dN would be positive and no maximum for Q would exist.
Thus it is necessary to assume that marginal costs are either decreasing throughout or
U-shaped. To be as general as possible, we shall suppose that the marginal cost function
C'(x) is a strictly convex function, which only requires that C"'(x) be positive or that the
slope of the marginal cost function be increasing.

Theorem 5. Given A.1 through A.7, C"'(x) positive, then if Q = Q(N) has a relative
maximum, such a maximum is global.

Proof. If Q = Q(N) has a relative extremum, there exists at least one real N such that
dQ/dN = 0. From theorem 3 or equation (10), this requires that f'- C" = 0. Thus
define the function
h(N) = f'[Q(N)] - C"[x(N)]. ... (12)

Let N, be any real root of h(N) = 0. Then unique

A global maximum requires, using Theorem 3 again
(12) and, using (10) and (11), yields

h'(N) =-(x/D)[(f '- C")f" + C"'(xf" +f')] . . .(13)

When N = N,
h'(N,) =-(x/D)C'(xf" +f') > 0,
which follows since x, D, and C"' are positive and (xf"+f') is negative.

Figure 1 shows the three possible shapes for the Cournot output function. Let Q be
the limiting output for functions Q2(N) and Q3(N), and let Qc be the limiting output for
Q1(N). The function Q1(N) represents the case in which there are no scale economies,
C"(x) > 0, and the Cournot model converges to competitive equilibrium, Qc (Theorem
The function Q3(N) represents the case where the Cournot model is quasi-competitive for
all N but does not converge to the competitive solution; thusf' - C" <0 for all possible N
and there must be economies of scale for at least the initial output levels. Sincef'-C"<0
states that the demand curve is always steeper than the marginal cost curve and the marginal
cost curve must initially be negatively sloped, Q3(N) corresponds to " mild " economies
of scale. The function Q2(N) represents the case in which there is a unique maximum (for
continuous N), implying thatf'-C" <0 for N<N and f'-C" >0 for N>N. The explan-
ation for this behaviour is clear enough. When more firms enter, the output of each firm
falls (Theorem 4) as the demand curve facing the firm is shifting to the left. For a given

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498 REVIEW OF ECONOMIC STUDIES

leftward shift in the firm's marginal revenue curve, th

cost curve is rising than if the marginal cost curve is falling. For " small " N, when the
output of the firm is large and marginal costs are rising or gently falling, the fall in the output
of the firm is more than offset by the additional firm(s). But with more firms, the output
of the firm continues to fall and, eventually, marginal costs will rise when economies of
scale are encountered (the marginal cost curve will be forward falling or backward rising).
If costs rise sharply enough, i.e., f'- C" >0, the fall in firm output will be large and not
offset by the extra firms.
So far we have said nothing about the viability of Cournot oligopoly. If there are mild
economies of scale or none at all, then viability is irrelevant to quasi-competitiveness. But

QC s
Qc~~~ Q, (N)

Q L - X
// _j-Q3(N~~Q3()

N~~~~~
FIGURE 1

if there are " strong " economies of scale at the initial output levels, there will be an output-
maximizing number for firms, N, and quasi-competitiveness will depend on the number of
firms. The next section gives some conditions under which N will or will not be consistent
with non-negative profits for each oligopolist. If N is unprofitable for each firm, quasi-
competitiveness is guaranteed. Thus the only case to consider is when there are some N's
greater than or equal to N for which profits can be made.
Imagine now there is free entry and, in long-run equilibrium, the Cournot oligopoly
settles down with some N>N. Then it must be so that f'- C">0. This violates one of
Hahn's stability conditions. Accordingly, it is probable that in this case the Cournot model
would become dynamically unstable before the long-run equilibrium could be attained.

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 RUFFIN COURNOT OLIGOPOLY 499

Several things might then happen: new patterns of behaviour could emerge (e.g., cartels
or competitive price-taking); entry could be curtailed by licensing arrangements, the
inability of new firms to obtain financing, etc., so that the number of firms would tend to
fall short of the output-maximizing number; or the industry might experience cycles of
instability and stability in which during the periods of instability the weaker and more
risk-averse firms leave. There is, of course, always the possibility that Hahn's stability
condition is not the relevant one. Okuguchi [9] has replaced this condition with a compli-
cated and economically meaningless restriction on the adjustment mechanism itself. The
beauty of Hahn's conditions is that they are the same as the static stability conditions that
can be derived from the Cournot duopoly case by considering the slopes of the reaction
curves and the usual simple-minded adjustment mechanism (e.g., Cournot [3, p. 67]).

V. AN EXAMPLE

If there is an output-maximizing number of firms, N, the Cournot model

quasi-competitive for N<N and, possibly, breaks down for N > N. Since the behaviour
of the model depends on the size of N relative to N, it behooves us to find out more about N.
Obviously, to say anything very general about N should be difficult; for N can always be
made sustainable (i.e., each firm making non-negative profits) by making the market
demand curve high enough and N can be " small " or " large " depending on the actual
cost and demand functions. But if we are willing to postulate a linear demand function,
a quadratic U-shaped cost curve, and admit apparently reasonable restrictions on the
parameters, two remarkable theorems can be established. The first is that the number of
firms that would exist in long-run competitive equilibrium, N*, is less than either N or the
maximum number of profitable oligopolists, Nm. The second is that N will not be sustain-
able if the initial slope of the average cost curve is at least twice as steep as the slope of the
demand function. Thus, quasi-competitiveness, if this condition is accepted, is necessary
for all sustainable N in the simple model described above.
Consider the following assumptions:

A.8. P = a0+a,Q, where a> 0 and a,<0.

A.9. C(x) = box+blx2+b2x2, where bo, b2>0 and b1 <0.
A.10. ao-bo>0.
A.11. al-b1>0.

Assumptions A.8 and A.9 obviously mean that the demand function is linear and the
average cost function A(x) is U-shaped as a general quadratic. A.10 means that the first
unit produced can be sold. The meaning of A. 11, however, is not so evident; but it says
that profit will fall to zero with a finite number of firms.
To see this, imagine a Cournot model with free entry. In long-run equilibrium, x,
Q, and N are determined by (14).

xf'+f(Q)-C'(x) = 0,

Q = xN,

xf(Q) = C(x). ...(14)

The last equation in (14) is nothing b
equations imply that
f'- (XC'-C)/x2.
But the right-hand side of this is the slope of the average cost function, dA(x)
A.8 and A.9 it follows that
xm = (a, -bl)/2b2, ...(15)

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 500 REVIEW OF ECONOMIC STUDIES

where the subscript " m " refers to a solution value of (14). Thus A. 11 means that xm is
positive or, in other words, that there is a finite number of firms that will drive profits to
zero.
To solve for the maximum number of firms consistent with non-negative profits, Nm,
rewrite the first equation of (14) using A.8 and A.9:

aO+a,Nx+alx = bo+2b1x+3b2x2. ...(16)

Substitute (15) into (16) and solve for Nm, yielding

Nm = [4b2(b0-a0)+B(b1+aj)]/2ajB, B = al-b1. ...(17)

From theorems 3 and 5 we know that the output-maximizing number of firms, N,
requires dQ/dN = 0 or f '- C" = 0. In our present model, this requirement is simply
a, 2b, + 6b2x. Thus
X= (al-2b1)/6b2 .. .(18)
is the output of the firm when output is maximized. A.8, A.9, and A. 11 imply that x is
positive. N may be obtained by substituting (18) into (16):

N 12b2(bo-a0)-A A2
2ajA =a1-2b, ...(19)
Finally, we must compute N*, the number of firms in long-run competitive equilibrium.
Obviously, the size of the firm, x*, must correspond to the minimum point of A(x). This
allows us to compute the competitive price and, hence, to compute Q* and N*. Carrying
out this elementary calculation gives

N* = -4b2(bo - ao) .. .(20)

2alb,
It remains to show that N* is less than either the output-maximizing number of firms,
N or the maximum number of viable (i.e., profitable) firms, Nm. Subtracting N* from N
and Nm establishes our result:

Theorem 6. Given A.9 through A.ll, the number offirms that wouldprevail in long-run
competitive equilibrium, N*, is exceeded by both the number offirms that maximizes Cournot
output, N, and the number offirms in Cournot oligopoly that yields zero profit, Nm.1

The practical consequences of Theorem 6 are interesting. It states that as N tends to

the number of firms that would prevail in competitive equilibrium, N*, the Cournot model
is viable and simulates competitive behaviour in that industry output rises and price falls.
Thus as long as it is easier to estimate N* than N, the theorem may make the task of testing
the Cournot model that much easier.
All the essential tools have been developed for answering one final question: will
Cournot oligopoly, under free entry, have more or fewer firms than the output-maximizi
number? If the maximum number of profitable Cournot oligopolists, Nm, is less than N
then the model is quasi-competitive for all sustainable N, and our potential ability to test
the Cournot model is increased. To answer the above question we need only examine the
sign of N_-N using (17) and (19). Taking common denominators and simplifying,

N_-N= (2a 1 -b)[AB-4b2(bo- ao)] ...(21)

m - ~2a1AB
1 Professor Bent Stigum and one of the referees have pointed out that N*, Nm, and N must be in
This problem can be handled by redefining N* as the largest integer consistent with (20); similarly w
Nm. But N is a bit harder; but in this case the largest integer consistent with (19) would give a lower bo
to N (since two maxima are possible). The only difference all this makes is that in Theorem 6 it would be
necessary to replace the strong inequalities by weak inequalities. We can see now why the assumption
of continuity is harmless for the purpose of this paper.

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 RUFFIN COURNOT OLIGOPOLY 501

where A and B are defined in (17) and (19). Under the assumptions, the expression in
brackets is positive and the denominator is negative. Hence, the sign of N_-N is the
same as the sign of b, -2a1. The most convenient way to express this result is as follows
Theorem 7. The maximum number of viable firms, Nm, will exceed the output maximizing
number offirms, N, if and only if
b1la, < 2; ...(22)
and N will exceed N. if and only if
b,/a, >2. ...(23)
Since b, is the slope of the aver
A'(0) be more than twice as steep as the demand function. This seems a more reasonable
condition, as when (22) is combined with A.1 1 it is necessary for bl/a, to lie between 1 and
2. Thus it is " likely " that the output-maximizing number of firms will be unprofitable
for each firm.

VI. CONCLUSIONS
The Cournot oligopolymodel gives us a plausible accountof a kind of quasi-competitive
behaviour in which economic performance (measured by industry output or price) is posi-
tively related to the number of firms. Yet the model does not generate the perfectly com-
petitive solution when the number of firms tends to infinity (except in the case where there
are no scale economies).
For the Cournot model, each firm can have an extremely small share of total industr
output; and, since market demand curves are used in the traditional way, each buyer
must be a price-taker (presumably, because there is a large number of buyers). This seems
paradoxical, since the usual assumptions of perfect competition are satisfied. What is
missing? The key is, I believe, that more must be said about buyers. It is not enough to
say that there are many price-taking buyers; for each firm faces a number of buyers and
may perceptibly influence price. To reduce this influence requires more buyers.
Imagine a Cournot oligopoly under free entry.' There is a U-shaped cost curve for
each identical firm, and the number of firms is such that profit is zero. In equilibrium,
the demand curve facing the firm is tangent to the left of the minimum point on the average
cost curve. Now let the number of buyers increase indefinitely. This makes the demand
curve flatter and flatter (e.g., assume each buyer has the same linear demand curve). Clearly,
by increasing the number of buyers the Cournot solution can become arbitrarily close to the
competitive solution. The number of firms, in this case, will be large; but it will be the
consequence of fundamental economic and technological conditions. In particular, not
only must each buyer be a price-taker, but the number of buyers must be sufficiently large
to give the market " breadth" relative to the size of the firm. Thus price-taking behaviour
(or what approximates such behaviour) and the large number of firms are the result of the
same set of conditions.
Competitive behaviour need not be accompanied by many firms. For example,
constant returns to scale and free entry will give the competitive solution regardless of th
number of firms, assuming entrepreneurs have sufficiently varied expectations.
We conclude that the number of firms may be a determinant of quasi-competitive
behaviour, but it is only an indicator, though not a necessary one, of competitive behaviour.

REFERENCES

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1 See Section V above, equations (14).

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502 REVIEW OF ECONOMIC STUDIES

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