ECO 2102: Assignment 1

Question 1. Consider the Cournot duopoly game with market demand given
by P = 100 − Q and each firm’s cost function given by c(q) = q 2 .

1. Does both firms producing 25 units each seem like a reasonable predic-
tion about what would happen in this market. In particular, if firm 2
produces 25 units, would firm 1 want to produce 25 units as well if its
objective is to maximize profits?

2. What if one firm were producing 24 units and the other firm 16 units?
Would both firms be happy to stick to these production levels given
what the other is producing?

3. What if both firms were producing 20 units each?

4. In the questions below, I use i, j to denote the two firms. Show that:

(a) If qj ≥ q ′ , then for i 6= j, producing any quantity qi that is greater

q′ ′
than 25 − 4
results in strictly less profit than producing 25 − q4 .
(b) If qj ≤ q ′′ , then for i 6= j, producing any quantity qi that is less
q ′′ q ′′
than 25 − 4
(assuming, 25 − 4
> 0) results in strictly less profit
q ′′
than producing 25 − 4
.

Hint: Holding qj fixed, plot i’s profit as a function of qi . Check what

happens to this profit graph as you increase/decrease qj . The question
may sound a bit complicated, but if you stare long enough at the plots,
the answer should stare you back!

Question 2. Suppose a manager and a worker interact as follows. The man-

ager decides whether to hire or not hire the worker. If the manager does not
hire the worker, then the game ends. When hired, the worker chooses to exert

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either high effort or low effort. On observing the worker’s effort, the manager
chooses to retain or fire the worker.

1. In this game, does “not hire” describe a strategy for the manager? Ex-
plain.

2. Write down the set of all strategies for the manager. How many possible
strategies does the manager have?

Question 3. Three firms, 1, 2 and 3, have to decide how much quantity of a

homogenous product to produce in a market with demand function P = 100
− Q. The firms choose their quantities dynamically as follows. First, firm 1
moves and decides how much quantity to produce. Then, firm 2, after having
observed firm 1’s production decision, decides how much to produce. Finally,
firm 3, after having observed both firm 1’s and 2’s production decisions, de-
cides how much to produce. Each firm’s cost of production is given by c(q)
= q 2 and their objective is to maximize profit.

Clearly specify the strategy sets of the 3 players.

Question 4. Watson (3rd ed.) Chapter 3 end of chapter exercises 3 and 4