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Business and Industrial Economics 2015 - 2016: Boris Mrkajic, PHD

This document provides solutions to exercises on oligopolistic market analysis. The solutions involve modeling market interactions using Cournot, Stackelberg, and Bertrand models. The summaries are: 1) The Cournot model is used to analyze a market with two firms competing in quantities. The equilibrium quantities and profits are calculated. 2) Another Cournot model analyzes how equilibrium is affected when one firm invests to reduce costs. 3) A Stackelberg model determines the equilibrium when one firm moves first as the leader and the other reacts as the follower.

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68 views5 pages

Business and Industrial Economics 2015 - 2016: Boris Mrkajic, PHD

This document provides solutions to exercises on oligopolistic market analysis. The solutions involve modeling market interactions using Cournot, Stackelberg, and Bertrand models. The summaries are: 1) The Cournot model is used to analyze a market with two firms competing in quantities. The equilibrium quantities and profits are calculated. 2) Another Cournot model analyzes how equilibrium is affected when one firm invests to reduce costs. 3) A Stackelberg model determines the equilibrium when one firm moves first as the leader and the other reacts as the follower.

Uploaded by

hurricane246
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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BUSINESS

AND INDUSTRIAL ECONOMICS


2015-2016

Boris Mrkajic, PhD


Analysis of oligopolistic markets Exercises solutions
Exercise 1 solution
As firms compete in quantities simultaneously, we solve a Cournot model.3
As both cost functions are linear, fixed costs of both firms are null ( = 0).
Both firms want to maximize their profits.
Firm 1 solves the following profit function:
max ! = ! + ! ! ! !
!!

max ! = (10 2 ! + ! ) ! 5!
!!

max ! = 10! 2!! 2! ! 5!


!!

Firm 2 solves the following profit function:


max ! = ! + ! ! ! !
!!

max ! = (10 2 ! + ! ) ! 2!
!!

max ! = 10! 2!! 2! ! 2!


!!

First order-condition for profit maximisation are:


!
!
= 0 &
= 0.
!
!
In particular,
!
= 10 4! 2! 5 = 0
!
!
= 10 4! 2! 2 = 0
!
Implying that:

! =

5 2! 5 !
=
4
4 2

! =

8 2!
!
=2
4
2

Solving this system of linear equations we get:


5 !

! = 2 4 2
2
5 2!
4

2! = 4

8! = 16 5 + 2!
=

And
=

! !!

Making the Cournot-equailbrium: ! , ! = (! , ! ).


Total quantity provided by the market is: =
!

Profits of the firms are: ! = !, ! =

!"!
!"

!"
!

, for the price of =

!"
!

Exercise 2 solution
As the firms compete in quantities simultaneously, we solve a Cournot model. Both firms want to maximize
their profits.
a) If Firm 1 decides not to invest, it pays nothing (! = 0), while it incurs cost of 1 for each unit
produced, meaning that its average and marginal costs are the same and they equal: ! = ! = 1. At
the same time, the total costs are: ! = ! .
Firm 2s total costs are: ! = 0, ! = ! = 1. At the same time, the total costs are: ! = ! .
In this case, both firms solve the following profit function
max ! = ! + ! ! ! !
!!

First order conditions yield:


!
= 3 2! ! 1 = 0
!

!
= 3 2! ! 1 = 0
!
! !

Solving this system of linear equations we get the Cournout-equalibrium: ! , ! = (! , !).


!

Total quantity provided by the market is: = !, for the price of = !.


!

Profits of the firms are: ! = !, ! = !.


b) If Firm 1 decides to invest, it pays initial investment (! = > 0), while it incurs no costs of each unit
produced, meaning that its average and marginal costs are the same and they equal: ! = ! = 0. At
the same time, the total costs are: ! = .
Firm 2s total costs are still: ! = 0, ! = ! = 1. At the same time, the total costs are: ! = ! .
In this case, Firm 1 solves the following profit function
max ! = ! + ! ! ! !
!!

max ! = (3 ! + ! ) !
!!

While Firm 2 solves the same profit function as in the previous case
max ! = ! + ! ! ! !
!!

max ! = (3 ! + ! ) ! !
!!

First order conditions yield:


!
= 3 2! ! = 0
!
!
= 3 2! ! 1 = 0
!
! !

Solving this system of linear equations we get the new Cournout-equalibrium: ! , ! = (! , !).
!

Total quantity provided by the market is: = !, for the price of = !.


Profits of the firms are: ! =

!"
!

, ! = !.

c) Based on the profits of Firm 1 with and without invest made, we can state that Firm 1 will find appealing
!"
!"
to invests iif the investment is lower than ! (!!"#$%& > !!"#!$%&' only if < ! ).
In the case of initial investmest, Firm 1 reduces its product costs (AC! = MC! = 0, after the investment),
and hence also benefits from increaseing its production (!!"#$%& > !!"#!$%&' ). As the reaction function of
!
Firm 2 in Cournot model is down-sloping (! = 1 ! ! , in this case), Firm 2 will have to decraese its
production. This is a consequence of the fact that quantities are strategic complements in Cournot model.

Exercise 3 solution
As the game is sequential, we solve a Stackelberg model, and one firm makes the decision first. We assume
Firm 1 is the first mover (leader), and Firm 2 is the second mover (follower). Both firms want to maximize
their profits.
We first derive the reaction function of the follower with respect to the assumed choice of the leader:
max ! = ! + ! ! ! !
!!

max ! = (100 ! ! ) ! 40!


!!

First order condition yields:


!
= 100 ! 2! 40 = 0
!
Firm 2 reaction function is:
1
! (! ) = 30 !
2
The total market demand is now:
1
= 70 !
2
Then, we derive the reaction function of the leader with respect to the reaction of the follower:
max ! = ! + ! ! ! !
!!

1
max ! = 70 ! ! 40!
!!
2
First order condition yields:
!
= 70 ! 40 = 0
!
=
=
The Stackelberg-equalibrium is: ! , ! = (30,15).
Total quantity provided by the market is: = 45, for the price of = 55.
Profits of the firms are: ! = 450, ! = 225.

Exercise 4 solution
As the firms compete in prices simultaneously, we solve a Bertrand model. Both firms want to maximize
their profits.

a) The firms solve the following profit function


max ! = ! ! !
!!

First order conditions yield:


!
= 12 12! + 5! = 0
!
!
= 10 + 2 12! + 5! = 0
!
Firm 1 reaction function is:
! ! = 1 +

12 !

Firm 2 reaction function is:


! ! =

5+ 5
+ !
6
12

b) Given = 1, rection function of Firm 2 is:


! ! = 1 +

12 !
!" !"

Solving this system of linear equations we get the Bertrand-equalibrium: ! , ! = ( ! , ! ).


!

Total quantity provided by each firm is: ! = ! = !.


!"

Profits of the firms are: ! = ! = !".


c) If the firms are symmetric (in the case of = 1, they indeed are), the prices are set equal to marginal
costs. This result is known as the Bertrand paradox, when the two firms charge a price equal to
marginal cost and hence incur zero extra-profits, while in other oligopolistic models (e.g. Cournot) the
price is higher than the Marginal Cost and guarantees to earn positive extra profits.

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