Firms indirectly determine price through output choices, rather than avoiding price-setting altogether. Each firm assumes its competitor’s production remains unchanged and then decides on its own output. Since both firms offer identical products, the total market supply influences the price.

Profit maximization is based on marginal revenue equaling marginal cost (MR = MC) rather than a general "balancing" of costs and earnings. The key idea is that a firm’s best decision depends on what its competitor is doing. Over time, both firms adjust their production levels until they reach a stable equilibrium where neither firm can increase its profit by changing output unilaterally. This outcome is known as the Cournot-Nash equilibrium, a specific type of Nash equilibrium, meaning no firm benefits from deviating on its own.

For example, think about two bakeries in the same neighborhood. Each bakery decides how many loaves of bread to bake daily, considering how much the other bakery produces. If one bakery increases its output, total supply rises, leading to lower prices and reduced revenue per loaf. Conversely, if a bakery reduces production, prices increase, potentially benefiting the competitor—but only if demand is sufficiently inelastic.

At equilibrium, both bakeries determine their output levels based on marginal revenue considerations, ensuring that neither can improve profit by altering production alone. The interaction of these output decisions is represented through reaction functions, which illustrate each firm's optimal response to the competitor's quantity choice. The intersection of these reaction functions defines the Cournot-Nash equilibrium, where both firms settle on production levels that maximize their respective profits while maintaining market stability.

Reaction curves illustrate this process. These curves show the best output decision for each firm based on what the competitor is producing. The intersection of these curves marks the equilibrium, where both firms have settled on production levels that maximize their profits without further adjustments.

This model demonstrates that firms in competitive markets are interconnected. The choices made by each company have an impact on the others, resulting in a steady and anticipated situation where neither can obtain an advantage without prompting a reaction from the rival.