ECON2216 Industrial Organization

Assignment 2

Spring 2024

Exercise 1. We study the effects of cartel size in this question. Suppose the total number of firms is fixed
at n (no further entry is possible). The market demand curve is linear:

Q = a − bp,

where a and b are positive constants, and Q and p denote the quantity demanded and market price respec-
tively. Each of the n firms has a linear marginal cost (MC) of

M C = d + eq,

where q is the output of the individual firms and d and e are positive constants.
(a) Find the elasticity of market demand .
(b) Find the equation of each individual firm’s supply curve under perfect competition, i.e. when they are
all price takers.
(c) Find the equation of the total supply curve (hint: Q = nq).
(d) Find the competitive equilibrium price and quantity.
(e) Now suppose that (n − j) firms in the market form a cartel and the remaining j firms (j < n) do not.
The non-cartel supply is then given by Qnc = jq. Find the equation of residual demand Qr that the
cartel faces.
(f) We know that the cartel acts as a monopoly with respect to its residual demand and sets its marginal
revenue M Rm equal to its marginal cost. Derive the marginal revenue function for the cartel.
(g) Let Qm denotes the cartel’s total production. It’s given (you can also try to prove it1 ) that the cartel’s
marginal cost is  
e
M Cm = d + Qm .
n−j
To maximize profit, we know that the cartel’s optimal level of production Qm (= Qr ) is determined by
equating the cartel’s marginal revenue with marginal cost. Find the optimal level of production for the
cartel.
(h) Will the cartel’s optimal output level fall as the number of nonmember firm rises?
Exercise 2. Intel and AMD, the primary producers of computer central processing units (CPU), compete
with one another in the mid-range chip category (among other categories). Assume that global demand for
mid-range chips depends on the quantity that the two firms make, so that the price for mid-range chips is
given by P = 210 − Q, where Q = qIntel + qAM D and where the quantities are measured in millions. Each
mid-range chip costs Intel $60 to produce. AMD’s production process is more streamlined; each chip costs
them only $48 to produce.
1 Intuitively, e
the n−j term captures the effect of spreading the production burden across multiple identical firms, leading to
a lower overall marginal cost for the cartel (economies of scale!)

1
 (a) Show that the profit function for each firm in terms of qIntel and qAM D are

πIntel = (210 − qIntel − qAM D − 60) × qIntel

and
πAM D = (210 − qIntel − qAM D − 48) × qAM D
for Intel and AMD respectively.

(b) Suppose each firm has 3 strategies by setting the quantity as 40, 50, or 60. The game table below
summarizes the profits under different combinations of quantities:

AMD
40 50 60
40 2800, 3280 2400, 3600 2000, 3720
Intel 50 3000, 2880 2500, 3100 2000, 3120
60 3000, 2480 2400, 2600 1800, 2520

Find all Nash equilibria (Hint: Identify the best responses for each firm and find all mutual best response
profiles)
(c) Now each firm can set their quantity as any number from 0 to 210. Find each firm’s best-response
function, equilibrium quantity and profit, and the equilibrium price in the market.
Exercise 3. Let’s study the Cournot model more generally. Assume that there are n firms, where n is
exogenously given. The output of the ith firm is qi and the total output Q is the sum of the output of each
firm: Q = q1 + q2 + . . . + qn . The (inverse) market demand function is given by p(Q) = a − bQ and each
Firm i’s total cost is given by C(qi ) = mqi , where a, b, and m are all positive constants.
(a) We know that Firm 1 tries to maximize its profit through its choice of q1 , i.e. Firm 1 chooses q1 to
solve
max π1 (q1 , q2 , . . . , qn ) = q1 · p(Q) − C(q1 )
q1

Write down the profit maximizing condition for Firm 1, and obtain the best-response function q1∗ (q2 , q3 , . . . , qn )
for Firm 1.
(b) From part (a), we know that each Firm i0 s best response function is given by
P
∗ a−m j6=i qj
qi (q−i ) = − ,
2b 2
P
where q−i denotes the quantities chosen by all firms besides Firm i and j6=i qj = q1 + q2 + . . . qi−1 +
qi+1 + . . . qn . Find the symmetric Nash equilibrium, i.e. find the Nash equilibrium in which all firms
choose the same quantity: q1∗ = q2∗ = . . . = qn∗ = q ∗ . What is the corresponding market price in this
equilibrium?
(c) For the symmetric Nash equilibrium found in part (b), if we set n = 1, we know that the equilibrium
price and quantity correspond to the monopoly price and quantity. What then would happen to the
equilibrium price and quantity as n approaches infinity?