Microeconomics Patrice De Micco

Oligopoly

Notice that in the exam you are required to show the computations you make. In the solutions of
the following exercises, sometimes, computations are missing and only the final result is
provided.

Exercises

1) Firms A and B compete à la Cournot. The market demand function is Q = 140 – P, where Q = QA + QB. The
two firms have constant and equal marginal costs: MCA= MCB = 20.

a) Compute the two firms’ best response functions.

Firm A’s profit is QA (140-QB- QA-20). Maximizing with respect to QA we obtain 120-QB- 2QA=0 and hence
QA=(120-QB)/2, A’s best response function. Symmetrically, B’s best response function is QA=(120-QB)/2.

b) Compute the equilibrium quantities, price, and profits.

Solving the system of equations describing the two firms’ best response functions we obtain the Cournot-Nash
equilibrium: QA=40, QB=40. The equilibrium price is P=140-(40+40)=60. Each firm’s equilibrium profit is
therefore 40(60-20)=1600.

c) How much is firm A willing to pay to have the right to move before firm B?
Firm A would be the Stackelberg leader, maximizing profit while taking into account B’s best response, that
is, QA(140-(120-QA)/2- QA-20). Maximizing this expression we get QA =60 and hence QB =30, from which we
get P=140-(60+30)=50. Firm A’s profit would therefore be equal to 60*(50-20)=1800. Thus, firm A is willing to
pay up to 1800-1600=200 to have the right to move before firm B.

2) Firms A and B compete à la Cournot. The market demand function is P = 72 – 2Q, where Q = QA + QB. The
two firms have constant and equal marginal costs: MCA= MCB = 12.

a) Compute the two firms’ best response functions.

Firm A’s profit is QA (72-2QB- 2QA-12). Maximizing with respect to QA we obtain 60-2QB- 4QA=0 and hence
QA=15-QB/2, A’s best response function. Symmetrically, B’s best response function is QA=15-QB/2.

b) Compute the equilibrium quantities, price, and profits.

Solving the system of equations describing the two firms’ best response functions we obtain the Cournot-Nash
equilibrium: QA=10, QB=10. The equilibrium price is P=72-2(10+10)=32. Each firm’s equilibrium profit is
therefore 10*(32-12)=200.

c) How much is firm A willing to pay for a technological innovation that lowers its marginal cost to MCA(QA) =
6?
If A’s marginal cost were MCA = 6, its best response function would be QA=(66-2QB)/4 and hence the
equilibrium would be QA=12, QB=9. The equilibrium price would be P=72-2(12+9)=30 and firm A’s profits would
be 12*(30-6)=288. It follows that firm A would be willing to pay up to 288-200=88 for the innovation.

3) Firms A and B compete à la Cournot. The market demand function is P = 190 – Q, where Q = QA + QB. The
two firms have constant and equal marginal costs: MCA= MCB = 10.

a) Compute the two firms’ best response functions.

Microeconomics Patrice De Micco

Firm A’s profit is QA (190-QB-QA-10). Maximizing with respect to QA we obtain 180-QB- 2QA=0 and hence QA=90-
QB/2, A’s best response function. Symmetrically, B’s best response function is QA=90-QB/2

b) Compute the equilibrium quantities, price, and profits.

Solving the system of equations describing the two firms’ best response functions we obtain the Cournot-Nash
equilibrium: QA=60, QB=60. The equilibrium price is P=190-(60+60)=70. Each firm’s equilibrium profit is
therefore 60*(70-10)=3600.

c) How much is firm A willing to pay for a technological innovation that lowers its marginal cost to MCA(QA) =
4?
If A’s marginal cost were MCA = 4, its best response function would be QA=(186-QB)/2 and hence the
equilibrium would be QA=64, QB=58. The equilibrium price would be P=190-(64+58)=68 and firm A’s profits
would be 64*(68-4)=4096. It follows that firm A would be willing to pay up to 4096-3600=496 for the
innovation.

4) Firms A and B compete à la Cournot. The market demand function is Q = 120 – P, where Q = QA + QB. The
total cost functions of A and B are CA(QA) = 15QA e CB(QB) =30QB respectively.

a) Compute the two firms’ best response functions.

A’s profit is QA (120-QB- QA-15). Maximizing this with respect to QA we get 105-QB- 2QA=0 and hence QA=(105-
QB)/2, which is A’s best response function. B’s profit is QB (120-QA- QB-30). Maximizing it with respect to QB
we get 90-QA- 2QB=0 and hence QB=(90-QA)/2, which is B’s best response function.

b) Compute the equilibrium quantities, price, and profits.

Solving the system of equations describing the two firms’ best response functions we obtain the Cournot-Nash
equilibrium: QA=40, QB=25. The equilibrium price is therefore P=120-(40+25)=55. A’s equilibrium profit is
40(55-15)=1600, while B’s profit is 25(55-30)=625.

c) How much would B be willing to pay for a new technology that allowed B to be as productive as A (so that
CB(QB) = 15QB instead of CB(QB) = 30QB)?
If B’s cost function were CB(QB) = 15QB , then B’s best response function would be QB=(105-QA)/2 and the
equilibrium would therefore be QA=35, QB=35. The equilibrium price would be P=120-(35+35)=50 and the
profit of each firm would be 35(50-15)=1225. Thus, B is willing to pay up to 1225-625=600 for the new
technology.

5) Firms A and B compete à la Cournot. The market demand function is Q = 180 – P, where Q = QA + QB. The
two firms have constant and equal marginal costs: MCA= MCB = 18.

a) Compute the two firms’ best response functions.

Firm A’s profit is QA (180-QB- QA-18). Maximizing with respect to QA we obtain 162-QB- 2QA=0 and hence
QA=(162-QB)/2, A’s best response function. Symmetrically, B’s best response function is QA=(162-QB)/2.

b) Compute the equilibrium quantities, price, and profits.

Solving the system of equations describing the two firms’ best response functions we obtain the Cournot-Nash
equilibrium: QA=54, QB=54. The equilibrium price is P=180-(54+54)=72. Each firm’s equilibrium profit is
therefore 54(72-18)=2916.

c) Alberto, the owner of firm A, offers 3000 euros to Bruno, the owner of firm B, in order to buy Bruno’s firm
and merge the two firms into one monopolistic firm (the profits of which would go entirely to Alberto). Does
Microeconomics Patrice De Micco

Bruno accept? Assuming that Bruno indeed accepts, what are the profits of the new monopolistic firm? Is
Alberto better off after the merging?
Bruno would accept, because 3000>2916. The new firm’s profit is Q(180-Q-18). The output level that
maximizes this profit is Q=81. Thus, the new firm’s maximum profit is 81(180-81-18)=6561. Since 6561-
3000=3561>2916, Alberto is better off after the merging.