Stackelberg competition

Definition

Stackelberg competition is a strategic game in economic theory where firms make decisions sequentially rather than simultaneously. In this model, one firm, known as the leader, sets its output level first, and the other firm, the follower, makes its decision based on the leader's choice. This dynamic creates a hierarchy in decision-making and can lead to different outcomes compared to simultaneous competition.

5 Must Know Facts For Your Next Test

1. In Stackelberg competition, the leader firm has a strategic advantage because it can commit to an output level before the follower does, influencing the latter's decision.
2. The model assumes that both firms have complete knowledge about each other's costs and market conditions when making their output decisions.
3. The equilibrium outcome often results in higher total industry output compared to Cournot competition due to the first-mover advantage held by the leader.
4. The Stackelberg model highlights the importance of timing and commitment in strategic decision-making between competing firms.
5. It is commonly used to analyze industries where firms can make sequential moves, such as in certain types of manufacturing or resource extraction.

Review Questions

• How does Stackelberg competition differ from Cournot competition in terms of decision-making and outcomes?
  • Stackelberg competition differs from Cournot competition mainly in the sequence of moves made by firms. In Stackelberg, the leader sets its output first, giving it an advantage over the follower, who must then decide based on this initial choice. This sequential decision-making can lead to different equilibrium outcomes, typically resulting in higher total output compared to Cournot competition, where firms decide simultaneously without knowing each other's choices.
• Discuss the implications of first-mover advantage in Stackelberg competition for strategic business planning.
  • The first-mover advantage in Stackelberg competition allows the leading firm to influence market dynamics by setting production levels that can affect pricing and supply. This advantage enables the leader to capture a larger market share and potentially earn higher profits than the follower. Businesses need to consider their positioning carefully and evaluate whether entering a market as a leader or a follower will yield better long-term results, affecting decisions around investment and resource allocation.
• Evaluate how Stackelberg competition could impact consumer prices and welfare compared to other forms of competition.
  • Stackelberg competition can lead to lower consumer prices due to increased overall industry output from the first-mover's advantage. Since the leader sets output first and maximizes profit while anticipating follower responses, this dynamic can create more competitive pricing than in simultaneous models like Cournot. Additionally, increased industry output may improve consumer welfare by providing more products at lower prices. However, if the leader engages in aggressive pricing strategies, it may also lead to reduced profits for the follower, impacting market structure in the long term.

Related terms

Cournot competition: A model of oligopoly where firms choose their output levels simultaneously and each firm considers the output of its competitors when making its own decision.

Nash equilibrium: A situation in a game where no player can benefit by unilaterally changing their strategy, given the strategies of the other players.

Game theory: The study of mathematical models of strategic interaction among rational decision-makers, often used to analyze competitive situations.