Problem Set 11

Question 1
In each payoff matrix shown below, determine the strategy of each player assuming they must play
simultaneously. Would collusion alter the outcome? Why or why not? Payoffs shown are A, B.
a.
B
B1 B2

A1 4, 2 1, 1
A
A2 2, 1 0, 0
b.
B
B1 B2

A1 –1, –2 1, –3
A
A2 2, 3 2, 2
c.
B
B1 B2

A1 3, 3 7, 2
A
A2 1, 7 6, 6

Question 2
In a Cournot duopoly, each firm has marginal cost MC = 20, and market demand is Q = 100 - 1/2p.
What are the best response functions of each firm? What is the best output level for each? How
does the total output level compare to the cartel output level?

Exercise 1
Firm A and firm B are the only producers of hamburgers in the market. The inverse market
demand for hamburger is p=70-Q where Q=qA+qB and qi is the amount produced by the i-th firm
(i=A,B). Duopolists engage in quantity competition. Each firm has a marginal cost of 10
(MCA=MCB=10) and no fixed cost.

1) Suppose the two firms choose quantities simultaneously. Find out firm A’s and firm B’s reaction
functions.

2) What are the equilibrium price, quantities, and profits of the two firms when they engage in
simultaneous quantity competition?

3) Suppose now that firm A has a chance to obtain the permission to produce hamburgers before
firm B. In this case, firm A can choose the quantity first. Find the new equilibrium under this
assumption.
4) What is the maximum amount of money that firm A is willing to pay to obtain the permission
and to choose the quantity first rather than simultaneously with firm B?

Exercise 2
The electricity market of New Light City is dominated by only 2 firms, whose names are Electric (E)
and Light (L). Their cost functions are given by: TCE = 2qE and TCL = 3qL. The two firms compete by
choosing simultaneously the quantity produced. The inverse market demand is given by P = 10 − Q,
where Q = qE + qL.

a) Can you say (without making any calculations) if, in equilibrium, both firms will produce the same
quantity or not?

b) Find the reaction functions of the two firms and draw them in a graph, indicating the slopes and
the intercepts.

c) Compute the quantity produced by each firm, the total quantity and the equilibrium market
price.

d) If the two companies compete by setting prices (Bertrand model), what will be the market
equilibrium in terms of quantities, price and profits of the two firms?