ECON0013 Problem Set 2

1) Consider an industry that consists of two firms. Firm 1 has the costs c(q1)= aq12 and the other firm
has the costs c(q2) = bq22. They are both producing the same product in a market with a demand curve
p = M-q.
a) Find each firm's reaction function in this industry. Explain why the intercepts of these
functions are different.
b) Find the Cournot-Nash equilibrium for this industry and determine the price.
c) What are the monopoly profits each firm could make if they were on their own in the
industry?
d) Now suppose that firm 1 is a leader and gets to choose its output level before firm 2 does.
What output would it choose?
e) Suppose the industry is re-organized. First, each firm simultaneously chooses their outputs
then (once these outputs are determined) they each choose a price for their product these
prices can be different, but the consumers always buy from the lowest-price firm. Draw a
game tree for this new game.
f) In this re-organized industry, suppose that firms have produced (q1,q2) and that firm 1 has set
the price p1= M-(q1+q2). Does firm 2 benefit from undercutting this price (i.e. choosing p2<p1)
assuming it cannot change the q2 units it has produced and all consumers prefer to buy from
the low price firm?

2) Two firms are engaged in Bertrand competition. There are 100 potential consumers who all are
willing to pay up to $5 for one unit of the good.
a) If firm 1 has a marginal cost of $1 and firm 2 has a marginal cost of $2, describe the outcome of
Bertrand competition in this case.
b) Suppose that each firm is only able to produce 80 units but they have the same marginal cost
of $1. When the price that firm 1 is proposing is $2 what is the best response of firm 2?

3) A monopolist has a demand curve of Q=30-2P and MR = 15-Q and has a MC = 2Q and
total costs = Q2+2. Where price is measured in dollars and quantity is measured in thousands.
(a) What price and quantity will maximize the company’s profits? (4 Points)
(b) A regulator imposes the maximum price of $10. What price and quantity will the monopolist
choose now? (6 Points)
(c) What is the best price for the regulator to set? (6 Points)