# Unifying Cournot and Stackelberg Action in a Dynamic Setting

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1 Unifying Cournot and Stackelerg Action in a Dynamic Setting TonüPuu 1 Introduction 1.1 Background Heinrich von Stackelerg, like Harold Hotelling, was one of those scientists of the early twentieth Century, who put down many seeds for new original ways to look at old prolems in theoretical economics, often pointing at paradoxical issues with no ovious solution. Stackelerg s contriution to duopoly (von Stackelerg, 1934, 1938), one Century after Cournot s initiation (Cournot, 1838), is proaly his most well known contriution. Even if Stackelerg departs from Cournot in his leader/follower dichotomy, in contrast to Cournot, there is no clue to any dynamization of the model. It is all static equilirium theory. One competitor can learn and take account of the Cournot reaction function of the other and then maximize profits. If the latter indeed follows the proper reaction function, everything is fine, there is a Stackelerg equilirium. The other competitor can do the same, and again, if the first then follows its reaction function, everything is fine again, there is another Stackelerg equilirium. They can also oth adhere to their reaction functions, and then one is ack to Cournot s original case. However, if oth competitors attempt leadership at once, then there is troule; oth are disappointed as expectations show up wrong. What will then happen? Will one of the competitors, or oth, resign leadership, and the system go to the Cournot or one of the Stackelerg equiliria? Stackelerg did not give any clue at all to this. A consequence of this is also that it is difficult to see how the Cournot and Stackelerg models at all fit together. Suppose one sets up a dynamic Cournot model, with, as it is popular to say now, naive expectations (as if not all hitherto modelled expectations were naive). Further, suppose one of the competitors chooses Stackelerg leadership action, and the other responds according to the Cournot reaction function. In the Cournot setting, even if the other competitor responds as T. Puu Department of Economics, Umea University UMEA, Sweden, G.I. Bischi et al. (eds.), Nonlinear Dynamics in Economics, Finance and the Social Sciences, DOI / , c Springer-Verlag Berlin Heidelerg

2 118 T. Puu expected, the first would in the next run of the Cournot game always find Cournot action etter than adhering to the leadership attempt. The Stackelerg equiliria can therefore simply not e considered as fixed points of the Cournot iterative map. And, as for the reverse, Stackelerg theory is just static. Current literature on Stackelerg duopoly focuses traditional static issues such as existence of equilirium, or compares equilirium profits to those from the Cournot case. (See Flam, Mallozzi, and Morgan (2002); Dastidar (2004); Colomo and Larecciosa (2008).) When dynamics is addressed the Stackelerg case is put in an adaptive system, as is often done with the Cournot case (see Richard (1980)), ut the present author has not seen any attempt to integrate the traditional Cournot and Stackelerg cases so that they turn up as fixed points of the same dynamic system. 1.2 Agenda We would like to formulate a single more general map in which oth the Cournot and the Stackelerg equiliria can exist as fixed points. To this end we suggest a rule for flipping etween Cournot and Stackelerg action on the asis of expected profits. The idea is to compare expected next period profits under Cournot action to profits resulting from Stackelerg leadership. But, as already mentioned, (naively expected) Cournot profits always exceed Stackelerg leadership profits, so we propose to locate the alance point etween current Cournot and Stackelerg profits, incorporating a scaling parameter. Such a rule is contestale, ut it is at least a start. By this, we can formulate a single model which contains oth the Cournot and Stackelerg solutions as fixed points, even including the point where oth competitors go on trying to remain leaders. The model may display multistaility, and it is also a specimen of heterogenous agent models. Normally, agent heterogeneity is taken to mean that the agents stick to the same kind of ehavior decided once and for all. In the proposed model they can and do shift ehavior, depending on the unfolding of the process itself. By the way, Stackelerg s original model must e one of the earliest heterogenous agent models ever proposed efore the term itself came in use. Having this agenda we choose a simple setup, used repeatedly y the present author: A smooth iso-elastic demand function comined with constant marginal costs for the competitors (see Puu (1991, 2004, 2000)). Arguments can e given oth for and against the iso-elastic case. To the advantage of the iso-elastic case speaks that it results for individual consumers from Co-Douglas utility functions, and further aggregates to the same kind of iso-elastic aggregate market demand function. The ovious alternative, linear demand functions, have discontinuity points, and they aggregate to a kinked train of linear segments resulting in a Roinson type of marginal revenue that jumps up and down. Such models with kinked linear demand functions may themselves offer prospects for interesting models (see Puu and Sushko (2002)), though they would complicate things unnecessarily in the present setting. An argualy minor disadvantage of the iso-elastic is that it is not suitale for the discussion of collusion or monopoly.

3 Unifying Cournot and Stackelerg Action Model Setup 2.1 Cournot Action Reaction Functions Assume the inverse demand function p D 1 x C y ; (1) where p denotes market price and x;y denote the outputs of the duopolists. Given the competitors have constant marginal costs, denoted a; respectively, the profits are U D x ax; (2) x C y V D y y: (3) x C y Putting the derivatives D 0 D 0, and solving for x;y, one otains r y x 0 D y; (4) a r x y 0 D x; (5) as the reaction functions. The dash, as usual, represents the next iterate, i.e., the est reply of one competitor given the oserved supply of the other Constraints Oviously, (4) returns a negative reply x 0 if y>1=a, and (5) a negative reply y 0 if x > 1=. To avoid this, we put x 0 D 0 whenever y>1=a,andy 0 D 0 whenever x > 1=. This means reformulating (4) (5) as follows ( q y x 0 D a y; y 1 a ; (6) 0; y > 1 a y 0 D ( q x x; x 1 0; x > 1 : (7)

4 120 T. Puu Equilirium Putting x 0 D x; y 0 D y, one can solve for the coordinates of the Cournot equilirium point x D.a C / 2 ; (8) a y D.a C / 2 : (9) Sustituting ack from (8) (9) in (2) (3), one gets the profits of the competitors in the Cournot equilirium point 2 U D.a C / 2 ; (10) a 2 V D.a C / 2 : (11) It is ovious that the firm with lower unit costs otains the higher profit Profits Note that (10) (11) are the profits in the Cournot equilirium point. During the Cournot iteration process (4) (5) profits can also e consideraly higher than in equilirium. As we will see elow, the Stackelerg leadership profits are always higher than the Cournot equilirium profits, ut in the Cournot process temporary profits can exceed the leadership profits. To calculate temporary profits, just sustitute from (4) into (2), and from (5) into (3), and otain U D 1 p ay 2 ; (12) V D 1 p 2 x : (13) Note that these may always seem to e nonnegative. But if y>1=aor x > 1=, i.e., the constraints for the first ranches of (6) (7) are violated, then this is due to the fact that negative costs dominate over negative revenues, which in terms of suject matter is nonsense. Anyhow, we already restricted the map (4) (5) to (6) (7), so we need not e further concerned Staility Of course, the Cournot equilirium (8) (9) can e stale or unstale. To check, calculate the derivatives of (4) (5)

5 Unifying Cournot and Stackelerg Action 121 In the Cournot point, sustitute from (8) (9) to D 1 1 p 1; (14) 2 D 1 1 p 1: (15) 2 D 1 2 a 1 2 D 1 a : Note that oth these Cournot equilirium derivatives have an infimum value 1 2 ; hence neither can ecome smaller than 1, ut either can ecome larger than 1, if a >3or a >3. Note that the derivatives always have opposite signs. To check staility, compose the Jacoian Iff 0 J D a 2 0 a 2a : (16).a / ˇˇˇˇ 2 <1 (17) ˇ 4a ˇ holds, then the Cournot equilirium is stale, otherwise not. The condition is equivalent to h3 a 2 2 p 2; 3 C 2 p i 2. In previous pulications (see Puu (1991, 2004, 2000)) it was shown that, once the equilirium point loses staility, there follows a period douling cascade of ifurcations to chaos. 2.2 Stackelerg Action First Equilirium According to Stackelerg s idea, the competitor controlling x can take the reaction function (5) of the other for given, and sustitute it in its own proper profit function (2), to otain U D p x ax: Putting du=dx D 0, and solving, one gets x D 4a 2 : (18)

6 122 T. Puu The corresponding value of y, provided that firm really adheres to its Cournot reaction function, is otained through sustituting (18) in (5) and equals y D 2a 4a 2 : (19) Using (18) (19) in (3), the Stackelerg leadership profit can e easily calculated U D 4a : (20) Second Equilirium Similarly, the second firm can try leadership, sustituting (4) in (3), and maximizing V D p ay y; to otain y D a 4 : (21) 2 The corresponding Cournot response of the first firm would then e and the Stackelerg leadership profit x D 2 a 4 2 ; (22) V D a 4 : (23) It is easy to check that Stackelerg leadership profits always exceed the respective Cournot equilirium profits, i.e., (20) is higher than (10), and (23) higher than (11) Staility Even if the Stackelerg model is static, we could consider staility as only the leader keeps to constant leadership action, (18) or (21), whereas the follower reacts according to the Cournot reaction function, (5) or (4) respectively. We can hence consider the staility of these partial reactions, as it is ovious that tiny disturances of the reacting competitor might make the system diverge from the Stackelerg equiliria. So, if the first firm is a Stackelerg leader, then sustituting from (18) in (15) D a 1; (24)

7 Unifying Cournot and Stackelerg Action 123 which can never ecome less than 1, ut can exceed 1. Hence, for staility we require a<2: (25) Likewise we can sustitute from (21) in (14), otaining and the staility D 1; (26) a a<2 (27) for the second Stackelerg equilirium. Note that the fulfilment of these staility conditions (25) and (27) also guarantee nonnegativity of the followership reactions according to (19) and (22). Further, note that the Stackelerg staility conditions (25) and (27) are stronger than the condition for Cournot staility (17) Prolems These equilirium solutions are consistent, provided one competitor in each case agrees to act as a Cournot follower. If not, there is a prolem that was noted y Stackelerg. But there is more to it ecause Cournot s theory is dynamic, Stackelerg s static. One may ask: Could the Stackelerg equiliria (18) (19) and (21) (22) e fitted into the Cournot dynamical system (4) (5) as fixed points of the map? The answer is no! If one competitor chooses to try leadership according to (18), and the other indeed follows according to (19), then, in the next move, retaining leadership y the first firm is no longer optimal under the dynamic Cournot map. The leader could in fact otain a higher profit through returning to Cournot action; after all Cournot est reply was defined that way. The Stackelerg equiliria hence cannot e fixed points of the dynamic Cournot map; it has to e modified in order to accommodate these additional fixed points. 3 A Proposed Map 3.1 Profit Considerations Aove in (6) (7), the output positivity constrained Cournot map was given. We now want to amend this map through considering possile jumping to Stackelerg leadership. It is close at hand then to compare current expected Cournot action profit, as given in (12) (13), to Stackelerg leadership profit according to (20) and (23). We assume that there is a certain proportionality constant k such that the firms keep to Cournot action as long as expected current profits are not less than Stackelerg

8 124 T. Puu leadership profits multiplied y this k,i.e., 1 p ay 2 k 4a ; (28) 1 p 2 a x k 4 : (29) The value of the parameter k indicates how adventurous the competitors are at attempting a jump to leadership action. 3.2 The Map We can now specify the map resulting from these considerations with three ranches for each actor. 8 q y ˆ< x 0 a y; y 1 a & 1 p ay 2 k 4a D ; y ˆ: 1 4a 2 a & 1 p ay 2 <k (30) 4a 0; y > 1 a ; 8 q x ˆ< x; x 1 1 & p 2 x k a 4 y 0 D a ; x 1 4 ˆ: 2 & 1 p 2 x <k a 4 0; x > 1 : (31) This map can accommodate the Cournot equilirium as well as oth Stackelerg equiliria. 4 Fixed Points 4.1 Cournot Equilirium Existence In order to confirm that the Cournot equilirium point is indeed located in its proper region of application we have to check (28) and (29) for the Cournot point (8) (9). Sustitutions result in just one single condition k 4a.a C / 2 ; (32) which depends on k and the ratio =a. The Cournot equilirium (8) (9) exists in its region of definition iff (32) holds. As the right hand side attains a unitary maximum value for a D, we conclude that for (32) to hold it is then necessary that k 1.

9 Unifying Cournot and Stackelerg Action Staility The staility conditions for Cournot equilirium were already stated aove, h a p 2; 3 C 2 p i 2 : As Cournot equiliria according to (32) can e defined for =a 2 Œ0; 1/ the requirement on staility constrains the existence region. 4.2 Stackelerg Equiliria Existence First Stackelerg Equilirium In a similar way we can deal with the existence prolem for the Stackelerg fixed points. Assume first that the firm supplying x is the leader, the firm supplying y the follower. Then the coordinates of the fixed point are (18) (19), whereas the conditions for the ranch definition are (28), sign reversed, and (29). Sustituting from (18) (19), we get two conditions, r! k> a a ; k 2 2 a a : Again note that they only depend on the parameter k andontheratio=a. Second Stackelerg Equilirium Reversing the roles of the firms, consider the fixed point (21) (22), which must fulfil the ranch conditions (28), and (29), sign reversed. Again, sustitution gives k 2 a 2 a ; r k> 2 2 a 2 a : In parameter space =a;k (displayed in Fig. 1), the Stackelerg equiliria are located in their proper ranch ranges in the two small lens shaped areas. Note that

10 126 T. Puu 2 k 2 L&L F L L F C a/ 1 /a 8 Fig. 1 Existence regions in parameter space for Cournot point (lower hump), the regular Stackelerg leader/follower pairs (small lens shaped areas), and simultaneous persistence on Stackelerg leadership (upper region with cuspoid ottomline) they are disjoint, and separated y a vertical line at =a D 1. Hence, for each parameter comination, only one of the Stackelerg equiliria exists as a fixed point (the one where the firm with lower unit cost is the leader). In the same picture we also display the lower region of existent Cournot fixed points. Note that it is disjoint from oth Stackelerg equilirium areas. Persistence on Leadership y oth Competitors Finally, under the proposed map, there can also exist a fixed point where oth firms keep to Stackelerg action, choosing (18) and (21) respectively. It is a fixed point of the map provided (28) and (29), oth signs reversed, hold, which upon sustitutions from (18) and (21) ecome k> 2 a 2 a ; k> 2 2 a a : The region in Fig. 1 of the parameter plane with the saw-toothed lower oundary represents the cases where oth firms keep to Stackelerg leadership, though it is not any normal Stackelerg equilirium. (In addition we have two more fixed points, where any one firm persists at its Stackelerg leadership, and supplies so much that the other firm drops out. Their regions of definition are not represented in the picture.)

11 Unifying Cournot and Stackelerg Action 127 As for the region outside the depicted existence regions for the fixed points, it is not possile to say from the preceding simple analysis which kinds of attractors may emerge there. Numerical experiment indicates periodic orits. Note the way Fig. 1 is constructed. The system is completely symmetric with respect to a and a. Therefore, actually two diagrams, in a ;k-space and in a ;kspace respectively were put ack to ack, with a increasing to the right, and a increasing to the left and a D a D 1 as the common dividing line. Had we chosen just one of the ratios as the horizontal coordinate, then one half of the diagram would have een squeezed in the interval.0; 1 whereas the other would extend over Œ1; 1/. This distortion would make it impossile to see the symmetry Staility We already concluded that the regular Stackelerg equiliria are stale if 1 2 <=a<2: Accordingly, the Stackelerg equiliria, unlike the Cournot equiliria, are always stale when they exist. 5 Numerical Study 5.1 Bifurcation Diagram Fixed Points In Fig. 2, the ifurcation diagram, resulting from numerical experiment performed to detect periodic orits of the system (30) (31) when starting from a point close to the Cournot equilirium point, is shown. To improve resolution, only the right half of the diagram as compared to Fig. 1 is displayed. Oviously most of the plane contains areas representing period 1 orits, i.e., attracting fixed points. These are of four different types (six in the format of Fig. 1), most of which can also e seen in Fig. 1 that represented existence regions for fixed points. 1. At the ottom of the picture the Cournot attracting equilirium area is shown. It looks quite as in Fig. 1, though it yields periodic orits where the Cournot equilirium turns unstale, at =a D 3 C 2 p 2,aswesaw. 2. There is also the tiny lens shaped attracting Stackelerg area for the leader/ follower pair, also quite as in Fig Likewise there is the region with the cuspoid ottom line, representing the non-standard Stackelerg case where oth competitors insist on sticking to Stackelerg leadership (which Stackelerg in the equilirium format considered

12 128 T. Puu 2 1 k /a 16 Fig. 2 Oservale are regions of periodic orits. There are fixed points (period 1) of four different types, further orits of periods 3, 4, 8, 10, 12, and 14. Enlargements may display more detail. The lack area indicates higher periodicity, quasiperiodicity, or chaos unresolvale). True, oth competitors get disappointed, as the assumption that the other acts as a follower does not hold, ut under the defined map, neither could find expected current profits from Cournot action more profitale. Also this region has a corresponding one in Fig There is further the region in the upper right part of Fig. 2, marked with a period 1 lael, which was not shown if Fig. 1. It represents the case where one competitor sticks to Stackelerg leadership, whereas the other finds no etter action than to suppress production altogether. It might seem to e a kind of monopoly. However, as mentioned in the introduction, the model, in particular the iso-elastic demand function, is not suitale to treat either monopoly or collusion. The reason is that under iso-elastic demand market revenue is a constant. Hence a monopolist (or a pair of collusive duopolists) could retrieve the whole revenue as profit without incurring any production costs if they produce nothing and sell this nothing at an infinite price. Such a solution is purely mathematical and has no meaning in terms of economics; it is just a shortcoming of one assumption. However, it can hardly e regarded as a major defect that the model is unsuitale for the analysis of market situations which in the real world as a rule are foridden y law. Further, the dynamic model proposed can never end up at monopoly or collusion, ecause the origin where the reaction functions (4) and (5) intersect (the collusion state) is as unstale as anything can e, oth derivatives according to (14) and (15) eing infinite at x D y D 0. There is just a little snag in the numerics; the computer interprets zero as an exact numer, so a computation may stick to the origin despite of its instaility. To avoid this, the exact zero in the definition of (30) (31) is replaced y a small numer " D 10 6 in the experiment.

13 Unifying Cournot and Stackelerg Action k /a 7.0 Fig. 3 Blowup picture of part of Fig. 2 to show more of periodic orits and overlaps. The lack regions indicate higher periodicities or more complex dynamics Periodic Orits As so much of the area in Fig. 2 is taken up y fixed point regions, little is left for other attracting orits. We can see periodic orits, laelled 3, 4, 8, 10, 12, and 14. This is at the chosen part of parameter plane and the resolution of the picture, as no higher periods were checked y the computer. The lack area may contain higher periodicities, quasiperiodicity, or even chaos. There seems to e some irregularity in the lower part of Fig. 2 in the interval a= 2 Œ6; 7, so we take a close up picture of it in Fig. 3. Notale are the two humps of a spiky appearance. They indicate coexistence of attractors; for some parameter cominations the chosen initial condition leads to one periodicity, for a neary comination to another. As we will see elow, the model is proficient in such coexisting attractors. There are many potentially interesting ifurcation scenarios to pursue. We will just pick one, with a= D 3 fixed, and k 2 Œ0:65; 0:75, indicated y the tiny line segment in Fig. 2. In Figs. 4 7, the phase diagram is displayed for k D 0:65, k D 0:7, k D 0:745,andk D 0: Attractors and Basins Coexistence The phase diagrams show the two Cournot reaction curves, along with the lines representing Stackelerg leadership action, further the different attractors, and their

14 130 T. Puu 0.4 y x 1.5 Fig. 4 Coexistent Cournot equilirium and six-period SIM cycle at a= D 3, k D 0: y x 1.5 Fig. 5 Coexistence of Cournot equilirium three-period cycle, and two six-period cycles, one SIM and one SEQ, at a= D 3, k D 0:7 asins of attraction. Note that the periodic orits are located on the intersection points of a grid of three or four horizontal and vertical lines, hence producing nine or sixteen attractor points. These are distriuted etween orits of different periodicities, such as 1 C 3 C 6 C 6 D 16,or3 C 6 D 9,or1 C 4 C 4 D 9. First, take a look at Fig. 5, where =a D 3; k D 0:7. As the fixed Cournot point is destailized only at k D 0:75, it remains stale. Its asin is the tiny rectangle around the intersection of the Cournot reaction curves, and a few other tiny rectangles in

15 Unifying Cournot and Stackelerg Action y x 1.5 Fig. 6 Same as previous picture at a= D 3, k D 0:745, though two asins are aout to disappear 0.4 y x 1.5 Fig. 7 The sucritical ifurcation, only the three-period cycle, and the six-period SEQ cycle remain at a= D 3, k D 0:75 the same shade. The cross, in the middle of which the main asin for the Cournot point lies, also contains the points of a six-period orit. In addition there is another six-period orit whose points lie on the Cournot reaction function (including the Stackelerg lines). Some researchers call such orits Markov perfect equiliria (MPE).In the present author s opinion this is misleading, as it is a periodic orit and no fixed point. Earlier literature in stead distinguished

16 132 T. Puu etween sequential adjustment (SEQ), where the competitors take turns in adjustment, and simultaneous adjustment (SIM), where they adjust oth at the same time; though it was elieved that the adjustment type must e chosen eforehand. The points of a SEQ orit necessarily lie on the reaction functions. Later it ecame ovious that a SIM system, that was more general, could itself settle on a SEQ orit. Despite this mistake the present author finds it etter to refer to the first six-orit as SIM, and to the second six-orit as SEQ. Finally, there is also a three-period orit. So, 1 C 3 C 6 C 6 D 16, quite as suggested. Next, consider Fig. 6, where k D 0:745, and the cross has almost disappeared. Hence the asin of the Cournot point has shrunk to almost nothing, as has the cross itself, which provides the asin for one of the six-period orits. The same orits remain as in the previous picture, though two of them are aout to disappear. This indeed happens at k D 0:75, the sucritical ifurcation in Fig. 7, where oth the Cournot equilirium, and one of the six-period cycles have disappeared. What remains are two attractors; the three-period orit, and the six-period SEQ cycle. In all, there are now 3 C 6 D 9 grid points in the intersections of three (horizontal and vertical) lines. For further increasing k, the three- and six-cycles remain. Finally, Fig. 4 displays the case k D 0:65. The higher Stackelerg line is not yet visited, so there is one SIM cycle, now of period 4, within the cross, and another SEQ four-period cycle, with points on the reaction functions, as its companion. Further, the Cournot point is, of course, also stale. In all, there are 1 C 4 C 4 D 9 periodic points on a grid of three y three lines. For k increasing from elow, this situation emerges at aout k 2 Œ0:61; 0:62. Forlowerk, there is just the Cournot equilirium point and one asin. It seems that the two four-period orits arise simultaneously at a ifurcation for some critical k, which notaly is consideraly lower than the value at which the Cournot equilirium is destailized Sucriticality The fact that Cournot point, contained in a small asin, remains along with other attractors indicates that the ifurcation from Cournot point to periodic orits is sucritical, i.e., the fixed point is not just destailized and replaced y another attractor as in the supercritical ifurcation. It rather disappears through its asin contracting and eventually vanishing, so that other attractors that already coexisted with it remain the only ones. The scenarios connected with such sucritical ifurcations often display quite complicated ifurcation structures in the oundary regions as shown in Agliari, Gardini, and Puu (2005a,). Further, sucritical ifurcations are hard compared to the soft produced y supercritical ifurcations, and lead to dramatic changes in the system when they occur.

17 Unifying Cournot and Stackelerg Action Profits It may e of interest to check average profits over the various coexistent cycles. Again take Fig. 5 for a start. The Cournot point profits are then U D 0:562; V D 0:062; as can e calculated from (10) (11) when a D 0:5; D 1:5. The firm facing three times higher marginal cost hence receives slightly more than one tenth of the profits of the other firm. According to (20), the first firm could even otain a profit U D 2:25 if it ecomes a Stackelerg leader in equilirium, ut this situation is not sustainale under the assumed parameter comination. For the three-cycle, profits ecome for the SEQ six-cycle and for the SIM six-cycle U D 0:377; V D 0:240; U D 0:446; V D 0:172; U D 0:461; V D 0:160: It hence always pays for the firm facing the higher marginal cost to try to reak out from a Cournot equilirium to a cyclic solution, as this alters the profit shares to its advantage; especially in the three-period cycle, where the profits of the duopolists have the same order of magnitude. For k D 0:745 or k D 0:75, Figs. 6 and 7, the situation remains the same, the profit entries are not even changed at the chosen numer of significant digits displayed, though in the latter case the Cournot equilirium and the SIM six-cycle no longer exist. As for the case k D 0:65, in Fig. 4, the facts are changed; the Cournot profits remain the same, ut for the four-period SEQ orit we get and for the four-period SIM orit U D 0:601; V D 0:074; U D 0:579; V D 0:070:

18 134 T. Puu Thus, the competitor facing the higher production cost can not earn much from periodic orits, the profits remain aout the same as in Cournot equilirium Rational Expectations The question now arises if the agents could learn the periodicity they produce. This is easiest if the periodicity is low and the coexistent attractors have the same period. We could choose the case displayed in Fig. 4, with just two four-period orits. But things ecome complicated enough, so check the facts at a parameter point =a D 6; k D 0:4 within the igger four-period tongue in Fig. 2. There then exists just one four-period cycle of SEQ type, and a unique asin. The four orit points are: (A) The competitor controlling y having chosen Stackelerg leadership, the one controlling x respondswith Cournotaction. (B) The competitor controlling y chooses Cournot action as it is etter under the map than keeping to Stackelerg action (C) The competitor controlling x again responds with Cournot action (D) The competitor controlling y now finds it etter to return to Stackelerg action. The profits from this four-cycle are now U D 0:725; V D 0:030; which is not much different from the Cournot profits ut the point is no longer stale. U D 0:735; V D 0:020; Given the simple regularity, suppose the agents learn the periodicity, and react, not to the competitor s action one period ack, ut four periods ack. What would e the outcome? If one only considers the dynamic every fourth period, the outcome is exactly as efore. But, in the three intervening periods, the system will settle to an independent cycle of the same type. The result is a composition of four four-cycles successively displaced in time, and, even if we just have one original cycle, it is impossile to make the composition reak down to a four-cycle. The outcome is a 16-period cycle. To see the point, consider a single four-cycle, whose points are denoted ABCD. Try to arrange a four cycle. In the first line of the tale there are three lanks etween the entries. To produce ABCD again, choose BCDA for the first lanks, CDAB for the second, and DABC for the third, thus completing the sequence. (Each new choice of entries is indicated in old face.)

19 Unifying Cournot and Stackelerg Action 135 A B C D A B B C C D D A ABC BCD CDA DAB ABC D BCDA CDAB DABC So what is the outcome? The resulting sequence in the ottom row indeed starts with ABCD, ut it is not repeated, ecause then follows BCDA, CDAB, and DABC. Only the full 16-sequence of the ottom line is repeated. So, if the agents learn the periodicity of 4, they actually produce a periodicity of 16. The reader can try to arrange the sequences differently, ut the outcome is always the same; a 16-period cycle. The first four entries in the sequence of 16 determine all the following, according to the order estalished in the original four-cycle, and as we have four choices for each entry, there would now seem to exist 4 4 D 256 different cycles. However, only 16 are different. The reason is as follows. Each recurrent sequence of 16 entries contains 16 different four-sequences of entries, as we can start with any one of the entries. (If we start with one of the three last entries, we just have to add one, two, or three of the entries in the eginning of the full sequence.) But, as any four susequent entries in the sequence determine the whole 16-period cycle, any of the 256 sequences elongs to a group of 16 identical orits (only chosen with different starting points). Hence, the total numer of distinct orits is 16. Note that average profits in the 16-period cycle remain the same as in the fourperiod cycle, ecause the same points ABCD are visited with the same relative frequency as efore though under different permutations. To sum up; starting with one four-period cycle and one asin, learning produced 16 different 16-period cycles, and, of course, 16 different asins, though. we cannot produce any picture of the asins in the phase diagram as it is eight-dimensional. And so it goes on, learning and adjusting to the 16 periodicity produces a host of different 256-period cycles. The conclusion is that the idea of rational expectations is untenale even in the simplest case of only one original orit of low order. The only periodicity that is possile to learn is a fixed point. For a general argument, see Puu (2006). 6 Discussion The purpose of this article was to define a dynamic duopoly system, as simple as possile, ut ale to contain oth the Cournot and the Stackelerg points as particular equiliria or fixed points. For this reason a traditional Cournot type of stepwise adjustment was assumed, ut it was amended through assuming that the competitors might jump to Stackelerg leadership action if they were too disappointed y currently expected Cournot profits. Depending on the two parameters of the simple system, the unit production cost ratio and the coefficient for jumping to attempts at leadership, different kinds of attractors could e detected.

20 136 T. Puu There could exist a stale Cournot equilirium state or various Stackelerg equiliria, and the system could also go to periodic solutions, such as 3, 4, 6, 8, 10, 12, or 14. In certain parameter regions there could even e attractors of higher complexity. A typical feature was that periodic attractors coexisted, with each other, and with fixed points, and that the ifurcations were sucritical. Stale Stackelerg points could exist for traditional leader/follower pairs (depending on the unit cost ratio), ut the system could also stick to oth competitors persisting in eing Stackelerg leaders. It could also happen that a Stackelerg leader managed to drive the competitor out of usiness. In certain situations of multistailty, the periodic orits provided for consideraly etter profit situations for the competitor facing high productions costs than would the Cournot equilirium. The question was also raised if the competitors could learn the actual periodicity and react accordingly with an appropriate delay. It was shown that even in the simplest cases of just one attractor of low periodicity this was impossile, ecause such learning and adaptation would inevitaly alter the resulting periodicity. In a superficial sense this is similar to the uncertainty principle in physics; in the present case learning and adapting to a periodicity the competitors produce is ound to change the periodicity itself. Rational expectationsare hence impossile, exceptfor the single case of a fixed point. The proposed integration of Cournot and Stackelerg, admittedly, is very simple, and should e amended y other strategic action rules that tell how the competitors reak out from situations that are neither Cournot points nor traditional Stackelerg leader/follower pairs. But it seems important to start trying to integrate Cournot and Stackelerg in one dynamic model. References Agliari, A., Gardini, L., & Puu, T. (2005) Gloal ifurcations in duopoly when the Cournot point is destailized through a sucritical Neimark ifurcation. Int Game Theory Rev, 8, Agliari, A., Gardini, L., & Puu, T. (2005) Some gloal ifurcations related to the apperance of closed invariant curves. Math Comput Simul, 68, Cournot, A. (1838) Récherces sur les principes mathématiques de la théorie des richesses. Paris Colomo, L. & Larecciosa, P. (2008) When Stackelerg and Cournot equiliria coincide. BE Journal of Theoretical Economics, 8, Article #1. Dastidar KG (2004) On Stackelerg games in a homogeneous product market. European Economics Review, 48, Flam, S. D., Mallozzi, L., & Morgan, J. (2002) A new look for Stackelerg-Cournot equiliria in oligopolistic markets. Economic Theory, 20, Puu, T. (1991, 2004) Chaos in duopoly pricing. Chaos, Solitons & Fractals, 1, , repulished in: Rosser, J. B. (Ed.) Complexity in economics: the international lirary of critical writings in economics (Vol. 174). Cheltenham: Edward Elgar. Puu, T. (2000) Attractors, ifurcations, & chaos nonlinear phenomena in economics. Berlin: Springer. Puu, T. (2006) Rational expectations and the Cournot-Theocharis prolem. Discrete Dynamics in Nature and Society, 32103, 1 11.

21 Unifying Cournot and Stackelerg Action 137 Puu, T., Sushko, I. (Eds.) (2002) Oligopoly dynamics. Berlin: Springer. Richard, J. A. (1980) Staility properties in a dynamic Stackelerg Oligopoly Model. Economic Record, 56, von Stackelerg, H. (1934) Marktform und Gleichgewicht. Berlin: Springer. von Stackelerg, H. (1938) Proleme der unvollkommenen Konkurrenz. Weltwirtschaftliches Archive, 48, 95.

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