Edgeworth's model of oligopoly
Edgeworth's model of oligopoly, developed by Francis Ysidro Edgeworth in the late 19th century, is a theoretical framework used to analyze strategic interactions among firms in an oligopolistic market. The model focuses on the strategic behavior of firms in terms of their production decisions and the resulting market outcomes.
In Edgeworth's model, it is assumed that there are two firms in the market, often referred to as Firm A and Firm B. Each firm aims to maximize its own profits by choosing its optimal quantity of output. The model assumes that the firms have knowledge of each other's strategies and anticipate how their competitor will react.
Key features of Edgeworth's model of oligopoly include:
Production decisions: Each firm independently chooses its quantity of output to produce. The firms recognize that their individual choices will affect market conditions, including the price and the quantity demanded by consumers.
Reaction functions: The firms' production decisions are influenced by the anticipated reaction of their competitor. These anticipated reactions are captured by the concept of reaction functions, which represent the optimal quantity choices of each firm given the quantity chosen by the other firm.
Nash equilibrium: The Nash equilibrium is a central concept in Edgeworth's model. It refers to a situation where neither firm has an incentive to unilaterally change its production decision, given the other firm's decision. In other words, it represents a stable outcome where both firms are simultaneously maximizing their profits.
Collusion and competition: Edgeworth's model can be used to analyze both cooperative and competitive behavior among firms. In the case of collusion, the firms may coordinate their production decisions to maximize joint profits. On the other hand, if the firms compete against each other, they may engage in strategic behavior to gain a competitive advantage.
Efficiency and market outcomes: Edgeworth's model provides insights into the efficiency of market outcomes in an oligopoly. The model allows for the examination of cases where the resulting market equilibrium is efficient, meaning that it maximizes overall social welfare, as well as cases where the equilibrium is inefficient due to market power or other factors.
It's important to note that Edgeworth's model of oligopoly is a simplified representation of real-world markets and may not capture all the complexities and nuances of actual oligopolistic behavior. Nevertheless, the model has been influential in understanding firms' strategic interactions and decision-making processes in oligopolistic markets.