Q. Initially there is one firm in a market for cars. The firm has a linear cost function: C(q)=2q.

The
market inverse demand function is given by P(Q)=9 − Q.

1. What price will the firm charge? What quantity of cars will the firm sell?
2. How much profit will the firm make?
3. Now, a second firm enters the market. The second firm has an identical cost function. What will
the Cournot equilibrium output for each firm be?
4. What is the Stackelberg equilibrium output for each firm if firm 2 enters second?
5. How much profit will each firm make in the Cournot game? How much in Stackelberg?
6. Which type of market do consumers prefer: monopoly, Cournot duopoly or Stackelberg duopoly?
Why?
1. The first two questions are about the case of monopoly. A monopolistic firm maximizes profits:

max y (9 − q) q − 2q. and the first order condition is 9 − 2q∗ M − 2=0. It follows that q∗ M = 9 − 2 2 = 7/2
and p∗ M = 9 − q∗ M = 9 − 7/2 = 11/2.

2. As for the profits in monopoly, they equal π∗ M = (9 − q∗ M) q∗ M − 2q∗ M = (9 − 7/2) 7/2 − 7 = 77/4 −
7 = 49/4

3. We are now in a Cournot competition set-up. A duopolistic firm maximizes profits: max yi (9 − (qi +
q−i)) qi − 2qi. (1) The first order condition of problem (1) is 9 − 2q∗ i − q∗ −i − 2=0. It follows that the
first order conditions for the two firms are 9 − 2q∗ 1 − q∗ 2 − 2=0. and 9 − 2q∗ 2 − q∗ 1 − 2=0. From the
first order condition, we get q∗ 2 = 7−2q∗ 1. We substitute this expression into the second order
condition to get 9 − 2 (7 − 2q∗ 1) − q∗ 1 − 2=0 or 3q∗ 1 = 7, so q∗ 1 = 7/ 3 and q∗ 2 = 7 − 2q∗ 1 = 7 – 2*
7/3 = 7 3 . Not surprisingly, the quantities produced by firms 1 and 2 are equal. The total market output
Q∗ = 2 ∗ 7/3 = 14/3.

4. In the Stackelberg case, firm 1 maximizes taking into account the reaction function of firm 2. The
reaction function of firm 2 is q∗ 2 (q1) = (7 − q1) /2. Therefore, firm 1 maximizes max q1 (9 − (q1 + (7 −
q1) /2)) q1 − 2q1 which leads to the first order conditions 9 − 2q1 − 7/2 + q1 − 2=0 or q∗ 1 = 7/2 and,
using the reaction function of firm 2, q∗ 2 = (7 − q∗ 1) /2=7/4. So the first mover produces twice as
much. The total market output is Q∗ = 7/2+7/4 = 21/4, larger than in Cournot.

5. In the Cournot case, the profit for either firm is πC = (9 − 14/3) 7/3 − 14/3 = 91/9 − 14/3 = 49/9.
Profits in Stackelberg differ. The profit of the leader is π1 = (9 − 21/4) 7/2 − 14/2 = 105/8 − 14/2 = 49/8
> πC, while the profit of the follower is π2 = (9 − 21/4) 7/4 − 14/4 = 105/16 − 14/4 = 49/16 < πc

6. Consumers prefer the market with the most total output (and by consequence the lowest price),
since this maximizes consumer surplus. Therefore, consumers prefer the Stackelberg duopoly, which
has the highest total production.

Q. In a duopolist market two firms can produce at a constant average and marginal cost of AC = MC
= 2. They face the market demand curve P = 14 – Q, Where Q = Q1 + Q2 where Q1 is the output of
Firm 1, Q2 is the output of Firm 2. In the Cournot’s model:

1. Find action-reaction functions of the two firms.

2. Calculate the profit maximising equilibrium price and output.
 3. What are the profits of the two firms?
4. Compare it with competitive equilibrium.

1. Given that the duopolists faces the following market demand curve: P = 14 – Q ∴ Q = Q1 + Q2

P = 14 – (Q1 + Q2) Both the firms have AC = MC = 2

Reaction Curve for Firm 1 Total revenue R1 is given by R1 = PQ1 = [14 – (Q1 + Q2)] Q1 ⇒ R1 = 14Q1 – Q1 2
– Q1Q2

MR=MC in equillibrium Q1 = .5 (12 – Q2) Similarly, Reaction curve for Firm 2 will be: Q2 = .5 (12 – Q1)

2. Q2=Q1=4; P=6
3. Profit of Firm 1 and Firm 2 is: = R1 – C1 = PQ1 – AC × Q1 = 6 × 4 – 2 × 4
4. Comparison of output under perfect competition and Duopoly:
Under Perfect Competition: P = MC i.e. 14 – Q = 2
Q = 14 – 2 ∴ Q = 12

Q. Assume three firms face identical marginal costs of 20 with fixed costs of 10. They face a market
demand curve of P = 200 – 2Q. Find the Cournot equilibrium price and quantity

R1 = (200 – 2(Q1 + Q2 + Q3))Q1 MR1 = 200 – 4Q1 – 2Q2 – 2Q3

Applying MR = MC: Q1 = 45 – Q2/2 – Q3/2

By symmetry: Q1 = Q2 = Q3 = 22.5

Q. Suppose that a monopolist has a marginal cost of Rs 4, and a fixed cost of Rs 48. Suppose also
that the demand curve is given by Q = 12 – (P/2).

1. What is the marginal revenue of the monopolist as a function of Q?

2. What is the profit maximizing price and quantity for the monopolist?
3. What is the efficient price?
4. What is the deadweight loss from the monopolist’s maximizing profits?

Q. Duopolists face the following market demand curve P = 30 – Q. Also, MC1 = MC2 = 0

1. What is the output in Cournot equillibrium?

2. If the two firms collude, what is the profit maximizing quantity?
3. If they agree to split their profits, what is the individual output?