HE401 Tutorial Exercise I

Question 1 Consider an oligopoly in which three type of rms X, Y and Z produce a homogeneous product with quantity x, y and z, respectively. The inverse market demand for the product is given by p = D(Q), with D 0. The conventional assumption that Q = x + y + z applies, i.e., the actual market price adjusts to the demand so as to clear the market at every period. All rms are assumed to have an identical technology and hence an identical convex cost function C(q), that is, C (q) > 0 and C (q) > 0 for all q > 0. The prot of each rm is thus given by (q, Q) = D (Q) q C (q). For the convenience, we shall denote q = Q q as the rest outputs of the industry for q = x, y, z. For instance, x = Q x = y + z. Firm X is assumed to be a price-taker, whose current production x is determined by equating the marginal cost incurred with the price. That is, for any given x, the output response x = Rx x is implicitly determined from the following identity: D = C (x) . (1)

Firm Y is a myopic absolute-prot optimizer (Cournot optimizer) with full information of the market. The output y = Ry y is implicitly but uniquely determined from the following rst-order prot maximization condition: D + D y = C (y) . (2)

Firm Z, in contrast, is a relative-prot optimizer whose objective is to maximize its relative-prot with respect to the average prots of rest rms in the industry: max (z, Q)
z z

1 ( (x, Q) + (y, Q)) 2

= max D (Q) z z /2 + (C (x) + C (y)) /2 C (z) As a result, the relative-prot maximizing response z = Rz z is implicitly derived from the following rst-order condition: 1 D + D (z z ) = C (z) 2 Assume that the marginal revenue condition is always satised, that is, D + qD < 0 for all q = x, y, z. Answer the followings: 1. Comparing the responses of the three types of rms for a given identical rest outputs, that is, ranking Rx q , Ry q and Ry q . 2. Let (, y , z ) be a Nash-equilibrium so that no rm has incentive to change. Comparing the equilibrium outputs x and the equilibrium prots. 3. What happens if one of the rms exits the market? (3)