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# Econ 106P: Practice Problems for Midterm

Yingju Ma
Aug 20, 2015
1. Vertical Market Separation with Bertrand Manufacturers
Consider a vertically separated market with the distributor as a monopoly in the retail market,
but with two manufacturers (producing identical products), 1 and 2, as Bertrand competitors. The
demand function of the retail market is P = 20 q, and the manufacturers cost function is C1 (q) = 2q
and C2 (q) = 4q.
A. What is the wholesale price?
B. How many units would the distributor purchase from the manufacturer?
C. Suppose that there exists a third competitor with cost function C3 (q) = 2q. How would your
answer change for the previous two questions?

## 2. Multiple Layers of Vertical Separation

Consider a retail market with demand function P = a

## bq. There is one manufacturer, denoted

M , and n distributors, denoted 1, 2, , n. The distributors are vertically aligned, i.e. distributor

## 1 and sells to the retail market, distributor n

2 and sells to n,

, and distributor 1 buys from M and sells to 2. The manufacturers cost function is C(q) = cq.
Parameters a, b, c are positive constants which satisfy a > c.

Each firm is a monopoly in their own market. The manufacturer sets a wholesale price PM ,
distributor i = 1, 2, , n

## and distributor n sets a retail price P .

A. What is firm ns demand function (i.e. the demand function faced by firm n
n

## 2s? (Hint: use backward induction.)

B. What is firm 1s demand function (i.e. the demand function faced by firm M )?
C. How many units will firm M produce? What will be the retail price?
D. When n becomes very large, what are the approximate price and quantity in the retail market?

## 3. Three-Firm Stackelberg Game

Consider a market with demand function P = 10 Q. Three firms, denoted 1, 2 and 3, are competing
in the following Stackelberg game: first firm 1 chooses its quantity q1 ; then firm 2 observes q1 and
chooses its quantity q2 ; then firm 3 observes q1 and q2 , and chooses its quantity q3 . The firms have
identical costs: Ci (qi ) = 2qi for i = 1, 2, 3.
A. What is firm 3s best response function?
B. Given your answer to 1, what is firm 2s best response function?
C. Given your answers to 1 and 2, what is firm 1s equilibrium quantity?