Game Theory - Homework Nº2

Felipe Garrido-Lucero

University of Paris Dauphine-PSL

Deadline: Exam’s day

This homework has only one problem the one is divided in three parts, each of them having
some questions to answer. It is important to follow the given order.

1 Cournot’s problem
Recall the Cournot’s problem in which two firms compete for producing the same item. If firm
1 produces q1 ≥ 0 and firm 2 produces q2 ≥ 0, the market unit price is equal to,

p(q1 , q2 ) = a − b(q1 + q2 ), where a, b ∈ R

We suppose that both firms have the same fixed production unit cost c > 0, with a > 0.
1. Compute the utility function of the firms assuming they sell their entire production.
2. Compute the best reply function of each firm by using the first order conditions.
3. Compute the Nash equilibrium of this game and the utility of each firm under equilibrium.

2 Cooperation in Cournot’s problem

Suppose the firms can cooperate and create a cartel producing an accumulated quantity Q =
q1 + q2 .

4. Compute the utility function of the cartel defined by the sum of the payoff functions of both
firms, in terms of Q.
5. Compute the optimal level of production Q∗ that maximizes the cartel’s utility.
6. Suppose that each firm is in charge of producing the half of the optimal production Q∗ , that
is, q1 = q2 = Q∗ /2. Compute the utility of each firm under this new level of production.

Observe than under cooperation both firms are better off than producing alone [you do not have
to prove it]. However, notice that each firm has an incentive to deviate to the Nash equilibrium
level of production when the other firm keeps cooperating [you do not have to prove it]. We
arrive to a prisoner’s dilemma situation. We will study if, under repetition, we can obtain the
cooperation of the firms as an equilibrium output.

3 Repeated Cournot’s problem

Suppose that both firms play infinitely many times the Cournot’s problem.

7. Compute the punishment level of firm 1 by solving,

v1 = min max {(a − b(q1 + q2 ))q1 − cq1 } ,

q2 ≥0 q1 ≥0

and explain why firm 2 has the same punishment level v2 .

8. By using the Folk Theorem conclude that the strategy profile in which both firms cooperate
at each stage is indeed a uniform equilibrium payoff.