11.11 : Stackelberg Competition

The Stackelberg model illustrates a type of oligopoly where a leading firm sets its production quantity, anticipating the reaction of follower firms, who then adjust their own output accordingly. The advantage for the leader in this model stems from being the first mover.

Consider a scenario with two competing electric car manufacturers, SwiftMotors and VelocityAuto. SwiftMotors takes the lead in the market by deciding its production quantity, with the goal of maximizing profits and establishing market dominance. In response to SwiftMotors' decision, VelocityAuto, as the follower, determines its own production level using a reaction function, aiming to optimize its profit while considering the market leader's choice.

SwiftMotors' higher initial production increases market supply, which may lower prices. However, the impact on price isn't definite and depends on the elasticity of market demand. Further, VelocityAuto produces fewer cars as the reaction function. Both companies eventually settle at production levels where neither benefits from changing their output. This balance is called the Stackelberg equilibrium, where the leader gains a competitive edge by moving first, and the follower adjusts to optimize its profit.

This model illustrates the power of making the first move in a competitive market. The leader can influence market conditions and maintain a competitive advantage by making early and strategic production decisions. In response, followers adapt their own strategies to maintain their competitiveness.