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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
n buys from n

1 and sells to the retail market, distributor n

1 buys from 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

1 each sets an intermediate price Pi (i.e. firm i + 1 buys at price Pi ),

and distributor n sets a retail price P .

Answer the following questions:
A. What is firm ns demand function (i.e. the demand function faced by firm n

1s? How about n

1)? How about

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.
Answer the following questions:
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?

Additional Problems in Textbook

The following questions help you to be familiar with the game theoretic analysis. You can find the
solutions in textbook.
Ch3: Questions 1, 3, 5.
Ch9: Questions 1,3, 5, 9(a).
Ch10: Guided Excise(p123); Questions 1, 3.
Ch15: Questions 3, 9.
Ch16: Guided Excise(p217).