Part II

Market structure and competitive strategy

Chapter 12 Monopolistic Competition and Oligopoly

Review Questions
1. Why is the firm’s demand curve flatter than the total market demand curve in monopolistic
competition? Suppose a monopolistically competitive firm is making a profit in the short run. What will
happen to its demand curve in the long run?
Answer: Because flatness or steepness of the firm demand curve is a function of the elasticity of
demand for the firm’s product. Elasticity of the firm’s demand curve is higher than the elasticity of
market demand because it is comfortably applicable for consumers to switch to another firm’s highly
substitutable product than to switch consumption to an entirely different product. Profit in the short run
induces other firms to enter. As new firms enter, the incumbent firm’s demand and marginal revenue
curves shift to the left, reducing the profit-maximizing quantity. In the long run profits is zero, so leaves
no chance for more firms to enter the industry of that product.

2. Some experts have argued that too many brands of breakfast cereal are on the market. Give an
argument to support this view. Give an argument against it.
Answer:
For producers there are too many brands of any single product signals excess capacity, assuming that
each firm is producing an output level smaller than the level that would minimize average cost. Limiting
the number of brands would therefore enhance overall economic efficiency of the market. And for
Consumers value the freedom to choose among a wide variety of competing products. Even if costs are
slightly higher as a result of the large number of brands available, the benefits to consumers more than
the additional costs for the mentioned market.
3. Why is the Cournot equilibrium stable? (i.e., Why don’t firms have any incentive to change their
output levels once in equilibrium?) Even if they can’t collude, why don’t firms set their outputs at the
joint profit-maximizing levels (i.e., the levels they would have chosen had they colluded)?
Answer: It is stable because each firm is producing the amount that maximizes its profit, given what its
competitors are producing. If all firms behave this way, no firm has a motivation to change its output.
Without collusion, firms find it difficult to agree tacitly to reduce output. If all firms were producing at
the joint profit-maximizing level, each would have an incentive to increase output, because that would
increase each firm’s profit at the expense of the firms that were limiting sales. But when each firm
increases output, they all end up back at the Cournot equilibrium. Thus it is very difficult to reach the
joint profit-maximizing level without overt collusion, and even then it may be difficult to prevent
cheating among the cartel members.

4. In the Stackelberg model, the firm that sets output first has an advantage. Explain why.
Answer: Because the second firm must accept the leader’s large output as given and produce a smaller
output for itself. If the second firm decided to produce a larger quantity, this would reduce price and
profit for both firms. The first firm knows that the second firm will have no choice but to produce a
smaller output in order to maximize profit, and thus the first firm is able to capture a bigger share of the
industry gains.

5. Explain the meaning of a Nash equilibrium when firms are competing with respect to price. Why is the
equilibrium stable? Why don’t the firms raise prices to the level that maximizes joint profits?
Answer: Nash equilibrium is when each firm chooses its price, assuming its competitors’ prices will not
change. In equilibrium, each firm is doing the best it can, conditional on its competitors’ prices. The
equilibrium is stable because each firm is maximizing its profit, and therefore no firm has an incentive to
raise or lower its price. No individual firm would raise its price to the level that maximizes joint profit if
the other firms do not do the same, because it would lose sales to the firms with lower prices. It is also
difficult to collude. A cartel agreement is difficult to enforce because each firm has an incentive to cheat.
By lowering price, the cheating firm can increase its market share and profits. A second reason that firms
do not collude is that such behavior violates antitrust laws. In particular, price fixing violates Section 1 of
the Sherman Act.
6. The kinked demand curve describes price rigidity. Explain how the model works. What are its
limitations? Why does price rigidity occur in oligopolistic markets?
Answer: In such a curve each firm faces a demand curve that is kinked at the currently prevailing price.
Each firm assumes that if it raises its price, the other firms will not raise their prices, and so many of the
firm’s customers will shift their purchases to competitors. This can cause a highly elastic demand for
price increases. Meanwhile, each firm believes that if it decreases its price, its competitors will also
decreases theirs, and the firm will not increase sales by much. This implies a demand curve that is less
elastic for price decreases than for price increases. This causes to a discontinuity in the marginal revenue
curve, so only large changes in marginal cost lead to changes in price. A major limitation is that the
kinked-demand model does not explain how the starting price is determined. Price rigidity may occur in
oligopolistic markets because firms want to avoid destructive price wars.

7. Why does price leadership sometimes evolve in oligopolistic markets? Explain how the price leader
determines a profit-maximizing price.
Answer: Because of the reason that producers cannot clearly be the in charge on setting price, they use
implicit means. One form of implicit collusion is to follow a price leader. The price leader, often the
largest or dominant firm in the industry, determines its profit-maximizing quantity by calculating the
demand curve it faces as follows: at each price, it subtracts the quantity supplied by all other firms from
the market demand, and the residual is its demand curve. The leader chooses the quantity that equates
its marginal revenue with its marginal cost and sets price to sell this quantity. The other firms match the
leader’s price and supply those others left in the market.

8. Why has the OPEC oil cartel succeeded in raising prices substantially while the CIPEC copper cartel has
not? What conditions are necessary for successful cartelization? What organizational problems must a
cartel overcome?
Answer: Best cartelization needs two specialty: one that demand should be relatively inelastic, and the
cartel must be able to control most of the supply. OPEC succeeded in the short run because the short-
run demand and supply of oil were both inelastic. CIPEC has not been successful because both demand
and non-CIPEC supply were highly responsive to price. A cartel has two problems: one that the
agreement on a price and a division of the market among cartel members, and it must assess and make
the agreement be applied.

Exercises

1. Suppose all firms in a monopolistically competitive industry were merged into one large firm. Would
that new firm produce as many different brands? Would it produce only a single brand? Explain.
Answer: Monopolistic competition is defined by product differentiation. Each firm earns economic profit
by distinguishing its brand from all other brands. This distinction can arise from underlying differences in
the product or from differences in advertising. If these competitors merge into a single firm, the
resulting monopolist would not produce as many brands.
However, it is unlikely that only one brand would be produced after the merger. The monopolist can sell
to more consumers and maximize overall profit by producing multiple brands and practicing a form of
price discrimination. Producing several brands with different prices and characteristics is one method of
splitting the market into sets of customers with different tastes and price elasticities.
2. Consider two firms facing the demand curve P = 10 – Q, where Q = Q1 + Q2. The firms’ cost functions
are
Firm 1 C1 = 4 + 2Q1
Firm 2 C2 = 3 + 3Q2
What is each firm’s equilibrium output and profit if they behave as Cournot duopolists? Draw the firms’
reaction curves and show the equilibrium.
3. A monopolist can produce at a constant average (and marginal) cost of AC = MC = $5. It faces a
market demand curve given by Q = 53 - P.
a. Calculate the profit-maximizing price and quantity for this monopolist. Also calculate its profits.
Answer: So at, P = 53 – Q, the marginal revenue curve has the same intercept and twice the slope:
MR = 53 - 2Q. MC(constant)= 5, and then:
53 - 2Q = 5, Q = 24
P = 53 - 24 = 29.
Profit = TR - TC = (29)(24) - (5)(24) = 576

b. Suppose a second firm enters the market. Let Q1 be the output of the first firm and Q2 be the output
of the second. Market demand is now given by
Q1 + Q2 = 53 - P.
Assuming that this second firm has the same costs as the first, write the profits of each firm as functions
of Q1 and Q2.
The profit functions for the two firms are:
Prodit1 = PQ1 – C(Q1) = (53-(Q1+Q2)) (Q1- 5Q1) = 48Q1 – Q12 – Q1Q2
Pprofit2 = PQ2 – C(Q2) = (53-(Q1+Q2)) (Q2- 5Q2) = 48Q2 – Q22 – Q1Q2

c. Suppose (as in the Cournot model) that each firm chooses its profit-maximizing level of output on the
assumption that its competitor’s output is fixed. Find each firm’s “reaction curve” (i.e., the rule that
gives its desired output in terms of its competitor’s output).
Answer: Regarding the Cournot assumption, we differentiate Profit1:
Profit1`= 48 – 2Q1 – Q2 = 0 so Q1= 24 – 1/2Q2 ,
so goes on with Profit2 :
Q2= 24 – 1/2Q1

d. Calculate the Cournot equilibrium (i.e., the values of Q1 and Q2 for which each firm is doing as well as
it is given its competitor’s output). What are the resulting market price and profits of each firm?
Answer:
Q1= 24 – ½(24-1/2Q1) , Q1 = 16
P = 53 – 16 – 16 = 21
Profit for Firm1 :
Profit = R – C =21*16 – 5*16 = 256 so 256+256 = 512

e. Suppose there are N firms in the industry, all with the same constant marginal cost, MC $5. Find the
Cournot equilibrium. How much will each firm produce, what will be the market price, and how much
profit will each firm earn? Also, show that as N becomes large, the market price approaches the price
that would prevail under perfect competition.
Answer:
P = 53 – (Q1+Q2+Q3+……+Qn)
Q1 = 24 – ½(Q1 + Q2 + Q3 + ……+ Qn)
so
q= 24-1/2 (N-1)q , q = 48/(N+1), and the demand function:
P = 53 – N (48/(N+1)) , the total profit is:
Profitt = [53 – N(48/N+1)]*(N) (48/N+1) – 5N {48/N+1} = 2304 {N/N+1}
The more firms increase, the least the profit becomes as follows:
Total Profit = 2304 {N/N+1} , in the long-run profit = 0

4. Suppose that two competing firms, A and B, produce a homogeneous good. Both firms have a
marginal cost of MC = $50. Describe what would happen to output and price in each of the following
situations if the firms are at (i) Cournot equilibrium, (ii) collusive equilibrium, and (iii) Bertrand
equilibrium.
a. Because Firm A must increase wages, its MC increases to $80.
(1) It is a Cournot when Firm A experiences an increase in marginal cost, its reaction function will shift
inward. The quantity produced by Firm A will decrease and the
.
quantity produced by Firm B will increase. Price increases and quantity decreases.
(2) collusive equilibrium: these two firms act together like a monopolist. When the marginal cost of Firm
A increases, Firm A will reduce its production to zero, because Firm B can produce at a lower marginal
cost. Because Firm B can produce the entire industry output at a marginal cost of $50, there will be no
change in output or price. However, the firms will have to come to some agreement on how to share the
profit earned by B is negotiated between these two firms.
(3) Before the increase in Firm A’s costs, both firms would charge a price equal to marginal cost (P $50)
because the good is homogeneous. After Firm A’s marginal cost increases, Firm B will raise its price to
$79.99 (or some price just below $80) and take all sales away from Firm A. Firm A would lose money on
each unit sold at any price below its marginal cost of $80, thus production would stop.

b. The marginal cost of both firms increases.

(1) That increase in the marginal cost of both firms will shift both reaction functions inward. Both firms
will decrease quantity produced and price will increase.
(2) When marginal cost increases, both firms will produce less and price will increase, as in the
monopoly discussion.
(3) The price increases to the new level of marginal cost and quantity decreases.

c. The demand curve shifts to the right.

(1) This is the opposite of the case in part b. In this situation, both reaction functions will shift outward
and both will produce a higher quantity. Price will tend to increase.
(2) Both firms will increase the quantity produced as demand and marginal revenue increase. Price will
also tend to increase.
(3) Both firms will supply more output. Given that marginal cost remains the same, the price will not
change.

8. Suppose the airline industry consisted of only two firms: American and Texas Air Corp. Let the two
firms have identical cost functions, C(q) = 40q. Assume the demand curve for the industry is given by P =
100 - Q and that each firm expects the other to behave as a Cournot competitor.
a. Calculate the Cournot-Nash equilibrium for each firm, assuming that each chooses the output level
that maximizes its profits when taking its rival’s output as given. What are the profits of each firm?
Answer:
Function of each firm: Profit1 = (100-Q1-Q2) Q1 – 40Q1= 60Q1 – Q12 – Q1Q2
Now we differentiate: Profit1` = 60- 2Q1 – Q2
Texas Air’s reaction function: Q1 = 30- 0.5Q2
American`s is also the same: Q2 = 30- 0.5Q1, now we substitute one instead of another:
Q1 = 30 – 0.5(30 – 0.5Q1), Q1 = 20, so 20 + 20= 40
Now we find out profit:
Profit1 = profit2 = 60*20 – 202 – 20*20 = 400

b. What would be the equilibrium quantity if Texas Air had constant marginal and average costs of $25
and American had constant marginal and average costs of $40?
Answer: First we find the equation of profit:
Profit1 = 100Q1 – Q12 – Q1Q2 – 25Q1 = 75Q1 – Q12 – Q1Q2
The differentiation of profit:
 dProfit1/dQ1 = 75 – 2Q1 –Q2 , Q1 = 37.5 – 0.5Q2 , since American keeps
the same policy so the function is the same too as: Q2 = 30 – 0.5Q1 , and as always we can find as
follows:
Q1 = 37.5 – 0.5(30 – 0.5Q1), Q1 = 30, and for Q2 we have:
Q2 = 30 – 0.5*30 = 15, so sum of the two is 15 + 30 = 45

c. Assuming that both firms have the original cost function, C(q) 40q, how much should Texas Air be
willing to invest to lower its marginal cost from 40 to 25, assuming that American will not follow suit?
How much should American be willing to spend to reduce its marginal cost to 25, assuming that Texas
Air will have marginal costs of 25 regardless of American’s actions?
Profits of two firms are $400 and industry price would be P = 100 - 30 - 15 = 55.
Profit of Texas Air:
(55)(30) - (25)(30) = 900.
The difference in profit is $500. So, Texas Air should be willing to invest up to $500 to lower costs from
40 to 25 per unit.
Now without investment, American’s profits would be:
(55)(15) - (40)(15) = 225.
then, with investment by both firms, the reaction functions would be:
Q1 = 37.5 - 0.5Q2
Q2 = 37.5 - 0.5Q1.
To find Q1, went on and found: Q1 = 25
because the firms are symmetric, so Q2 is also 25.
Substituting industry output into the demand equation to determine price:
P = 100 - 50 = 50.
Both firms have MC = AC = 25 then profit is:
Profit2 = (50)(25) - (25)(25) = 625.

9. Demand for light bulbs can be characterized by Q = 100 - P, where Q is in millions of boxes of lights
sold and P is the price per box. There are two producers of lights, Everglow and Dimlit. They have
identical cost functions:
Ci = 10Qi + 1/2Qi2(i = E, D) Q = QE + QD
a. Unable to recognize the potential for collusion, the two firms act as short-run perfect competitors.
What are the equilibrium values of QE, QD, and P? What are each firm’s profits?
Answer:
MCi = 10 + Qi, Ci = 10Qi + 1/2Qi2
And P = 100 –Q1 –Q2 =10 + Q1 also P = 10+ Q2, so now 100 – Q1 – (90 –Q1 ) = 10 + Q1 ,
Q1= 30, Q2 = 30 then:
Profit1 = 40*30 – (10*30 + 0.5*302) = 450

b. Top management in both firms is replaced. Each new manager independently recognizes the
oligopolistic nature of the light bulb industry and plays Cournot. What are the equilibrium values of QE,
QD, and P? What are each firm’s profits?
Answer: Since it is Cournot-Nash equilibrium, then the reaction function is:
Pe = (100 – Qe – Qd)Qe –(10Qe + 0.5Qe2) = 90Qe – 1.5 Qe2 – QeQd
(derivation) 90 – 3Qe – Qd = 0 , Qe = (90- Qd)/3
Also Dimlit`s reaction function: Qd = (90- Qe)/3
By substituting them: Qe = 22.5
45 = 100 – P, P= 55
Now the Profit1 = 55*22.5 – (10*22.5 + 0.5 * 22.52) = 759.4

c. Suppose the Everglow manager guesses correctly that Dimlit is playing Cournot, so Everglow plays
Stackelberg. What are the equilibrium values of QE, QD, and P? What are each firm’s profits?
Answer:
Dimlit`s reaction function: Qd = 30 – Qe/3
So we find : Profit(e) = 60Qe – 7Qe2/6
The derivative state: 60 – 7Qe/3 = 0, Qe = 25.7
Also Qd = 30 – 25.7/3 = 21.4 , 25.7+ 21.4 = 47.1 (total output) for P = 52.9
Profit(e) = 772.3 , Profit(d) = 689.1
d. If the managers of the two companies collude, what are the equilibrium values of QE, QD, and P? What
are each firm’s profits?
Answer: C1 = 10(Q/2) + ½(Q/2)2 and both of them: TC = 10Q + Q/2)2
MC =- 10 + 0.5Q , P = 100 – Q , MR = 100 - 2Q then MR = MC so:
100 – 2Q = 10 + 0.5Q , Q = 36 , Qe =Qd = 18
P = 100- 36 = 64
Now determining profit:
Profit1 = 64*18 – (10*18+0.5*182) = 810
And marginal Revenue regarding monopolists with two plants:
MR = 100 – 2(Qe + Qd) = 10 + Qe = MCe
MR = 100 – 2(Qe + Qd) = 10 + Qd = MCd , Qe = Qd = 18
MULTIPLE CHICE QUESTION

Chapter 12

Monopolistic Competition and Oligopoly

1) For which of the following market structures is it assumed that there are barriers to entry?

A) Perfect competition

B) Monopolistic competition

C) Monopoly

D) all of the above

2) Use the following two statements about monopolistic competition to answer this question. I. In the
long run, the price of the good will equal the minimum of the average cost. II. In the short run, firms may
earn a profit.

A) I and II are true.

B) I is true, and II is false.

C) I is false, and II is true.

D) I and II are false.

3) A market with few entry barriers and with many firms that sell differentiated products is

A) purely competitive.

B) a monopoly.

C) monopolistically competitive.

D) oligopolistic

13) Which of the following is true for both perfectly competitive and monopolistically competitive firms
in the long run?

A) P = MC.

B) MC =ATC.

C) P > MR.

D) Profit equals zero.

14) Which of the following is true in long-run equilibrium for a firm in monopolistic competition?

A) MC = ATC.

B) MC >ATC.

C) MC < ATC.
D) Any of the above may be true.

23) In the __________, each firm treats the output of its competitor as fixed and then decides how
much to produce.

A) Cournot model

B) model of monopolistic competition

C) Stackelberg model

D) kinked-demand model

E) none of the above

24) A __________ shows how much a firm will produce as a function of how much it thinks its
competitors will produce.

A) contract curve

B) demand curve

C) Reaction curve

D) Nash equilibrium curve

E) none of the above

Scenario 12.1: Suppose mountain spring water can be produced at no cost and that the demand and
marginal revenue curves for mountain spring water are given as follows: Q = 6000 - 5P MR = 1200 - 0.4Q

28) Refer to Scenario 12.1. What is the profit maximizing price of a monopolist?

A) $400

B) $600

C) $800

D) $900

E) none of the above

29) Refer to Scenario 12.1. What will be the price in the long run if the industry is a Cournot duopoly?

A) $400

B) $600

C) $800

D) $900

E) Competition will drive the price to zero.

41) Which oligopoly model(s) have the same results as the competitive model?
A) Cournot

B) Bertrand

C) Stackelberg

D) Both Cournot and Stackelberg

42) In which oligopoly model(s) do firms earn zero profit?

A) Cournot

B) Bertrand

C) Stackelberg

D) Oligopoly firms always earn positive economic profits.

48) Two firms operating in the same market must choose between a collude price and a cheat price.
Firm A's profit is listed before the comma, B's outcome after the comma.

50) Consider the following payoff matrix for a game in which two firms attempt to collude under the
Bertrand model:

Here, the possible options are to retain the collusive price (collude) or to lower the price in attempt to
increase the firm's market share (cut). The payoffs are stated in terms of millions of dollars of profits
earned per year. What is the Nash equilibrium for this game?

A) Both firms cut prices.

B) A cuts and B colludes.

C) B cuts and A colludes.

D) Both firms collude.

51) Consider the following payoff matrix for a game in which two firms attempt to collude under the
Bertrand model:

Here, the possible options are to retain the collusive price (collude) or to lower the price in attempt to
increase the firm's market share (cut). The payoffs are stated in terms of millions of dollars of profits
earned per year. What is the Nash equilibrium for this game?
A) Both firms cut prices.

B) Both firms collude.

C) There are two Nash equilibria: A cuts and B colludes, and A colludes and B cuts.

D) There are no Nash equilibria in this game.

Scenario 12.2: You are studying a market for which the kinked demand curve model applies. The kinked
demand curve is as follows: Q = 1200 - 5P for 0 . Q < 150 Q = 360 - P for 150 . Q The marginal cost is
given as: MC = Q

61) Refer to Scenario 12.2. What is the profit maximizing level of output?

A) 171.43

B) 120

C) 150

D) all of the above E) none of the above

62) Refer to Scenario 12.2. What is the profit maximizing price?

A) 205.72

B) 240

C) 210

D) all of the above

E) none of the above

63) Refer to Scenario 12.2. Suppose that the marginal cost increases such that: MC = Q + 10 What is the
profit maximizing level of output?

A) 171.43

B) 120

C) 150

D) all of the above

E) none of the above

64) Refer to Scenario 12.2. Suppose that the marginal cost increases such that: MC = Q + 10 What is the
profit maximizing price?

A) 205.72

B) 240

C) 210
D) all of the above

E) none of the above

65) Refer to Scenario 12.2. Suppose that the marginal cost falls such that: MC = Q - 10 What is the profit
maximizing level of output?

A) 171.43

B) 120

C) 150

D) all of the above

E) none of the above

66) Refer to Scenario 12.2. Suppose that the marginal cost falls such that: MC = Q - 10 What is the profit
maximizing price?

A) 205.72

B) 240

C) 210

D) all of the above

E) none of the above

Scenario 12.3: Suppose a stream is discovered whose water has remarkable healing powers. You decide
to bottle the liquid and sell it. The market demand curve is linear and is given as follows:

P = 30 - Q

The marginal cost to produce this new drink is $3.

79) Refer to Scenario 12.3. What price would this new drink sell for if it sold in a competitive market?

A) 0 B) $3 C) $13.50 D) $16.50 E) $27

80) Refer to Scenario 12.3. What is the monopoly price of this new drink?

A) 0 B) $3 C) $13.50 D) $16.50 E) $27

81) Refer to Scenario 12.3. What will be the price of this new drink in the long run if the industry is a
Cournot duopoly?

A) $3 B) $9 C) $12 D) $13.50 E) none of the above

82) Refer to Scenario 12.3. What will be the price of this new drink in the long run if the industry is a
Stackelberg duopoly?

A) $3 B) $9 C) $12 D) $13.50 E) none of the above

83) Refer to Scenario 12.3. What will be the price of this new drink in the long run if the industry is a
Bertrand duopoly?

A) $3 B) $9 C) $12 D) $13.50 E) none of the above

84) Refer to Scenario 12.3. What will be the price of this new drink in the long run if the firms in the
industry collude with one another to maximize joint profit?

A) $3 B) $9 C) $12 D) $16.50 E) none of the above

85) A firm operating in a monopolistically competitive market faces demand and marginal
revenue curves as given below:
P = 10 - 0.1Q MR = 10 - 0.2Q
The firm's total and marginal cost curves are:

where P is in dollars per unit, output rate Q is in units per time period, and total cost C is in
dollars.

a. Determine the price and output rate that will allow the firm to maximize profit or minimize
losses.
Answer: MC = MR
-10 + 0.10Q2 = 10 - 0.2Q
0.1Q2 + 0.2Q - 20 = 0 so Q1 = 13.17 Q2 = -15.15.
then Q1 = 13.2
P = 10 - 0.1(13.2) = 8.7
b. Compute a Lerner index.
P - MC
Answer: L =
P
When Q = 13.2, P = 8.7, and MC = 7.4
L = (8.7 - 7.4)/8.7 = 0.2

86) Suppose that the market demand for mountain spring water is given as follows:
P = 1200 - Q
Mountain spring water can be produced at no cost.

a. What is the profit maximizing level of output and price of a monopolist?

Answer: MR = 1,200 - 2Q
MR equals the MC then we have:
1,200 - 2Q = 0
Q = 600
P = 1,200 - 600 = 600
b. What level of output would be produced by each firm in a Cournot duopoly
in the long run? What will the price be?
Answer: The reaction curve for firm 1 is as bellow:
 R1 = PQ1 = (1,200 - Q)Q1 = 1,200Q1 - (Q1 + Q2)Q1 = 1,200Q1 - Q12 - Q2Q1
So we differentiate Renvenue:

Reaction curve1 = Q1 = 600 - (1/2)Q2 and Reaction curve2 = Q2 = 600 - (1/2)Q1

So now we have this: Q1 = Q2 = 400 and totally 800.

c. What will be the level of output and price in the long run if this industry were
perfectly competitive?

Answer: MC = P
P = 1,200 - Q = 0 or Q= 1,200 and P = 0

88) Two large diversified consumer products firms are about to enter the market for a new pain
reliever. The two firms are very similar in terms of their costs, strategic approach, and market
outlook. Moreover, the firms have very similar individual demand curves so that each firm
expects to sell one-half of the total market output at any given price. The market demand
curve for the pain reliever is given as:
Q = 2600 - 400P.
Both firms have constant long-run average costs of $2.00 per bottle. Patent protection insures
that the two firms will operate as a duopoly for the foreseeable future. Price and quantity
values are stated in per-bottle terms. If the firms act as Cournot duopolists, solve for the firm
and market outputs and equilibrium prices.
Answer: now we are going to find the price as follows:
Q = 2600 - 400P
Q - 2600 = -400P
P = 6.5 - 0.0025Q

Now reaction functions.

TrA = PA · QA = (6.5 - 0.0025Q)QA or TrA = 6.5QA - 0.0025[(QA + QB)QA]
Finally TrA = 6.5QA - 0.0025QA2 - 0.0025QAQB
And MrA = 6.5 - 0.005QA - 0.0025QB
6.5 - 0.005QA - 0.0025QB = 2
-0.005QA = 4.5 + 0.0025QB
QA = 900 - 0.5QB

Now it goes again so:

QB = 900 - 0.5QA
QA = 900 - 0.5(900 - 0.5QA)
QA = 900 - 450 + 0.25QA
QA -0.25QA = 450
QA(1 - 0.25) = 450
QA = 600
Also:
QB = 900 - 0.5(900 - 0.5QB) = 900 - 450 + 0.25QB
QB = 600, 600 + 600 = 1200
Now:
P = 6.5 - 0.0025(1200)
P = 3.5

89) Lambert-Rogers Company is a manufacturer of petrochemical products. The firm's research

efforts have resulted in the development of a new auto fuel injector cleaner that is considerably
more effective than other products on the market. Another firm, G.H. Squires Company,
independently developed a very similar product that is as effective as the Lambert-Rogers
formula. To avoid a lengthy court battle over conflicting patent claims, the two firms have
decided to cross-license each other's patents and proceed with production. It is unlikely that
other petrochemical companies will be able to duplicate the product, making the market a
duopoly for the foreseeable future. Lambert-Rogers estimates the demand curve given below
for the new cleaner. Marginal cost is estimated to be a constant $2 per bottle.
Q = 300,000 - 25,000P.
where P = dollars per bottle and Q = monthly sales in bottles.

a. Lambert-Rogers and G.H. Squires have very similar operating strategies. Consequently, the
management of Lambert-Rogers believes that the Cournot model is appropriate for analyzing
the market, provided that both firms enter at the same time. Calculate Lambert-Rogers' profit-
maximizing output and price according to this model.
Answer:
TRL = PL · QL = (12 - 0.00004Q)QL and Q = QL + QS then:
TRL = [12 - 0.00004(QL + QS)]QL = 12QL - 0.00004QL2 - 0.00004QLQS
MRL = 12 - 0.00008QL - 0.00004QS regarding MRL = MC we have:
12 - 0.00008QL - 0.00004QS = 2 now, QS = 125,000 - 0.5QL
Substitute for QS:
QL = 62,500 + 0.25QL = 83,333 and now 83,333 + 83,333 = 166,666
P = 12 - .00004(166,666) = $5.3

b. Lambert-Rogers' productive capacity and technical expertise could allow them to enter the
market several months before Squires. Choose an appropriate model and analyze the impact of
Lambert Rogers being first into the market. Should Lambert-Rogers hurry to enter first?
Answer:
TRL = 12QL - 0.00004QL2 - 0.00004QLQS , then we put equl of QS by QL now:
TRL = 12QL - 0.00004QL2 - 0.00004QL(125,000 - .5QL)
So now we have: TRL = 7QL - 0.00002QL2 and MRL = 7 - 0.00004QL due to MRL = MC we have:
7 - 0.00004QL = 2
 QL = 125,000

Then we ago ahead so:

QS = 125,000 - 0.5QL = 125,000 - 0.5(125,000) , QS = 62,500
Q = QL + QS
Q = 125,000 + 62,500 = 187,500
P = 12 - 0.0004(187,500) = $4.50
And we find L:
L= 8.7-7.4)/8.7 = 0.15

90) The two leading U.S. manufacturers of high performance radial tires must set their
advertising strategies for the coming year. Each firm has two strategies available: maintain
current advertising or increase advertising by 15%. The strategies available to the two firms, G
and B, are presented in the payoff matrix below.

The entries in the individual cells are profits measured in millions of dollars. Firm G's outcome
is listed before the comma, and Firm B's outcome is listed after the comma.

a. Which oligopoly model is best suited for analyzing this decision? Why? (Remember it is
illegal to collude in the United States.)
Answer: In this case the prisoner's dilemma model is most applicable because each firm sould
state its own advertising strategythat is possible without knowing about another competitor `s.

b. Carefully explain the strategy that should be used by each firm. Support your choice by
including numbers.
Answer: Since the firm is better with increasing witgout considering of the rival's step,
increasing the advertising is the best action, For example, if Firm B increases, Firm G earns 27 if
it increases and 12 if it does not increase. G is better off increasing. If Firm B doesn't increase,
Firm G earns 45 by not increasing and 50 by increasing. Again, Firm G is better off to increase.
It is obvious that no matter what B does, G is the place to increase firm B is also in this situation
which discussed above.

91) The market for an industrial chemical has a single dominant firm and a competitive fringe
comprised of many firms that behave as price takers. The dominant firm has recently begun
behaving as a price leader, setting price while the competitive fringe follows. The market
demand curve and competitive fringe supply curve are given below. Marginal cost for the
dominant firm is $0.75 per gallon.
 QM = 140,000 - 32,000P
QF = 60,000 + 8,000P,
where QM = market quantity demanded, and QF = the supply of the competitive fringe.
Quantities are measured in gallons per week, and price is measured as a price per gallon.

a. Determine the price and output that would prevail in the market under the conditions
described above. Identify output for the dominant firm as well as the competitive fringe.
Answer:
QM = 140,000 - 32,000P
QF = 60,000 + 8,000P
Considering:
QD = QM - QF
QD = 140,000 - 32,000P - (60,000 + 8,000P)
QD = 80,000 - 40,000P

Then: QD - 80,000 = -40,000P , P = 2 - 0.000025QD

MR = 2 - 0.00005QD, now, 2 - 0.00005QD = 0.75
QD = 25,000
P = 2 - 0.000025(25,000) = 1.4
QF = 60,000 + 8,000(1.4) = 71,000
In total = 25,000 + 71,000 = 96,000
b. Assume that the market demand curve shifts rightward by 40,000 units. Show that the
dominant firm is indeed a price leader. What output (leader and follower) and market price will
prevail after the change in demand?

Answer: QM = 180,000 - 32,000P

QF = 60,000 + 8,000P
QD = 180,000 - 72,000P - (60,000 + 8000P)
QD = 120,000 - 40,000P
and for finding the price we go as below:
QD - 120,000 = -40,000P
PD = 3 - 0.000025QD
MRD = 3 - 0.00005QD then, 3 - 0.00005QD = 0.75
QD = 45,000 , PD = 3 - 0.000025(45,000) = 1.875
QF = 60,000 + 8,000(1.875)
QF = 75,000
QT = 75,000 + 45,000 = 120,000

92) In the town of Battle Springs, the market for fast food is dominated by Mr. Berger.
The other companies tend to follow Mr. Berger's lead in setting price and style of burger. The
total demand for cheeseburgers in Battle Springs is:
P = $1.50 - $0.00015Q.
The marginal cost of producing and serving burgers at Mr. Berger is:
MCL = 0.25 + 0.0000417Q.
The competitive supply curve of burgers by all the other (competitor) firms is:
Pf = 0.50 + 0.000285Qf.
Compute the price that will be set in the market when Mr. Berger behaves as a dominant firm
and maximizes profit for itself. Also, compute the production rate by Mr. Berger and the
competitor firms.
Answer: When MCL = MRL so now we ca find the price:
P = 1.50 - 0.00015Q, or Q = 10,000 - 6,666.67P
P = 0.50 + 0.000285Qf, or Qf = -1,754.40 + 3,508.77P.
Then it goes so
QL = 10,000 - 6,666.67P + 1,754.40 - 3,508.77P
QL = 11,754.40 - 10,175.44P or P = 1.155 - 0.0000983Q
Now MR for Mr. Berger has:
RL = P · QL = 1.155QL - 0.0000983QL2
MRL = 1.155 - 0.000197QL then 1.155 - 0.000197QL = 0.25 + 0.0000417QL
Finally we have: QL = 3,791 , PL = 1.155 - 0.0000983(3,791) = 0.78 .
. Qf = -1,754.40 + 3,508.79(0.78) = 982.5

93) Consider two identical firms (no. 1 and no. 2) that face a linear market demand curve. Each
firm has a marginal cost of zero and the two firms together face demand:
P = 50 - 0.5Q, where Q = Q1 + Q2.

a. Find the Cournot equilibrium Q and P for each firm.

Answer:

MC1 = 0, then we have now:

50 - 1Q1 - 0.5Q2 = 0
Q1 = 50 - 0.5Q2 , and aslo , Q2 = 50 - 0.5Q1
Equilibrium: Q2 = 50 - 0.5(50 - 0.5Q2)
Q2 = 33.3
Q1 = 50 - 0.5Q2 = 50 - 0.5(33.33) = 33.3
33.3+33.3= 66.6

b. Find the equilibrium Q and P for each firm assuming that the firms collude and share the
profit equally.
Answer: R = PQ - (50 - 0.5Q)Q = 50Q - 0.5Q2, and thus
MR = 50 - Q , 50 - Q = 0 , Q = 50 , Q1 =Q2 = 25

c. Contrast the efficiencies of the markets in (a) and (b) above.

Answer: The market is more efficient when the firms compete, because in this situation selling
price is more nearly equal to marginal cost because when they competing with eachother, each
firm produces 33.3 at a price of 16.6; and when colluding, each produces 25 at a price of 25. .