PROBLEM SET 7.

2 - ON OLIGOPOLY GAMES

1. [Cournot competition in supply volumes] A new rice-market has come up near Kolkata,
and only two whole-sellers, B and G, have the potential to supply rice (of identical quality) to
that market. The whole-sellers operate out of Kolkata, and they have to decide
simultaneously on how many quintals of rice to supply to the market every morning.
Logistical problems preclude them from changing the daily supply decision once it is made.
The daily demand for rice in the market is given by: quintals demanded = 60 – price. Both
firms know that once their supplies reach the market, a market-maker will set the price such
that the day’s demand equals the day’s supply. B’s daily cost of supplying b quintal per day
is: CB(b) = F + uB.b for all b > 0 (with CB(0) = 0), while the daily cost of supplying g quintal
per day for G is: CG(g) = F + uG.g for all g > 0 (with CG(0) = 0). Here, F is the common
(avoidable) fixed costs of each whole-seller, uB is the (constant) unit cost of whole-seller B,
and uG is the (constant) unit cost of whole-seller G. The objective of each whole-seller is to
maximize daily profits.
Find the Cournot-Nash equilibrium of this rice-supply game for the following ‘cost values’:
(i) F = 20, uB = uG = 30; (ii) F = 80, uB = uG = 30; and (iii) F = 20, uB = 30, uG = 36.

2. [Cournot competition in capacities] Two chemical processing firms – X and Y – who are
planning to produce the same chemical C, are simultaneously determining what annual
capacities – KX and KY – to install. Annual demand for chemical C is: QD = 1000 – P. For
each firm, the total cost of installing k units of capacity is 400k for all k ≥ 0.
The following technological features are present in the chemical industry: (i) Once capacity
is installed, production costs up to capacity are zero for each firm. (ii) If a firm installs
annual capacity K, it is extremely costly for it to produce any amount other than K in any
given year. (iii) It is quite costly to hold any inventory of unsold chemicals in any year.
The above technological features imply the following pricing behavior given the annual
market demand function: If firm X installs annual capacity KX and firm Y installs annual
capacity KY, then in every subsequent year each firm will set its output price at: P = 1000 –
(KX + KY) so that it can ensure that its entire annual production will get sold in the year. In
words, the technological conditions are such that each firm is required to “produce and sell at
installed capacity” in every year.
The annual interest rate in the economy is 10%, and there is no inflation.
Given the above information, note that if firm X installs annual capacity KX and firm Y
installs annual capacity KY at the beginning, the net present value of firm X’s profits will be:
10.[1000 – (KX + KY)]KX – 400KX, and the net present value of firm Y’s profits will be:
10.[1000 – (KX + KY)]KY – 400KY.
[Present value profits derive from the fact that the infinite sum {X/(1+r) + X/(1+r)2 + X/(1+r)3 + …}
equals {X/r}. We will consistently assume that yearly profits accrue at the end of the year.]

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PROBLEM SET 7.2

If the objective of each firm in choosing its annual capacity (simultaneously and once-and-
for-all-times) is to maximize the net present value of its profits, determine the Cournot-Nash
equilibrium capacity choices of the two firms.

3. [Impact of product differentiation on Bertrand competition] In the Coke-Pep Bertrand

game studied in class, consider the case where the symmetric demand structures for the two
Cola companies i and j are given by: Di(Pi, Pj) = 45 – 50Pi + d(Pj – Pi), for some “product
differentiation parameter” d  (50, 350). Express the best response function of each firm i in
terms of d. Derive the Bertrand-Nash equilibrium prices when d = 100 and when d = 300.

4. [Bertrand competition with identical products] Two firms A and B sell identical dining-
tables. There are 100 consumers in the market; each consumer demands at most one dining
table, and has maximum willingness to pay = Rs.5000. The two firms set their unit prices
simultaneously as Bertrand duopolists. If the two firms charge the same price (no greater
than Rs.5000), 50 consumers will buy from each firm. If the two firms charge different
prices, all 100 consumers will buy from the lower-price firm (as long as the price is no
greater than Rs.5000).
(i) If each firm has unit production cost of Rs.2000, what prices will the firms set in a
Bertrand-Nash equilibrium, and how many dining-tables will each firm sell?
(ii) If firm A has unit cost of Rs.2000 while firm B has cost Rs.2500, what prices will the
firms set in a Bertrand-Nash equilibrium, and how many dining-tables will each firm sell?

5. Consider a four-firm Cournot Oligopoly. The annual market demand function is: Q D =
800 – P, and the annual cost function for each firm is: TC = 200q for q ≥ 0. Derive the best
response for each firm as a function of aggregate rival supply. Establish the annual Cournot-
Nash equilibrium outcome for the four firms in the industry.