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Practice Problems 7 Topic: Cournot and Bertrand Equilibria

This document contains 4 practice problems related to microeconomic theory involving Cournot and Bertrand competition between firms. Problem 1 involves calculating the reaction functions and Cournot-Nash equilibrium for 2 farmers producing milk. Problem 2 does the same for a duopoly with linear demand and costs. Problem 3 generalizes to an n-firm Cournot model with zero costs and exponential demand. Problem 4 considers Bertrand competition between 2 firms with constant marginal costs and discrete pricing.

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141 views2 pages

Practice Problems 7 Topic: Cournot and Bertrand Equilibria

This document contains 4 practice problems related to microeconomic theory involving Cournot and Bertrand competition between firms. Problem 1 involves calculating the reaction functions and Cournot-Nash equilibrium for 2 farmers producing milk. Problem 2 does the same for a duopoly with linear demand and costs. Problem 3 generalizes to an n-firm Cournot model with zero costs and exponential demand. Problem 4 considers Bertrand competition between 2 firms with constant marginal costs and discrete pricing.

Uploaded by

jinnah kay
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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200C − Micro Theory − Professor Giacomo Bonanno

PRACTICE PROBLEMS 7
Topic: Cournot and Bertrand equilibria
VERY IMPORTANT: do not look at the answers until you have made a VERY serious
effort to solve the problem. If you turn to the answers to get clues or help, you are wasting a
chance to test how well you are prepared for the exams. I will not give you more practice
problems later on.

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1. In the town of Middleofnowhere there are only two farmers and they are the only
producers of milk. The local demand for milk is given by (P denotes price measured in
cents, Q denotes the total quantity measured in cartons): P = 2000 − 2Q.

Both farmers have the same cost function given by (C is total cost measured in cents
and q is output measured in cartons): C = 80,000 + 560 q.

(a) Calculate and draw the reaction (or best reply) function of firm 1 (that is,
calculate the profit-maximizing output of firm 1 for every possible output of
firm 2). Do the same for firm 2.

(b) Calculate the Cournot-Nash equilibrium (give the output of each firm, the total
output, the price and the profit of each firm).

(c) Compare social welfare (profits + consumer surplus) at the Cournot-Nash


equilibrium with the social welfare that would result if there were only one
firm in the industry (with the same cost function as above). How do you
explain the result?

2. Consider an industry where there are only two firms (a duopoly). The industry demand
1
function is given by Q = 100 − P (where P is price and Q is total quantity). Both
3
firms have the following total cost function (where q denotes output): TC = 150 + 2q.
Competition is Cournot style (each firm independently chooses its own output level)
(a) Write down the profit function of each firm.
(b) Calculate the reaction function of firm 1.
(c) What output should firm 1 produce if it expects its rival to produce 20 units?
(d) Find the Cournot-Nash equilibrium.

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3. There are n firms. Production costs are zero for each firm. Each firm chooses the
quantity it produces, denoted by qi. Let Q be total industry output, i.e. Q = q1 + q2 +
... + qn. The price at which the good is sold is given by the inverse demand function

P = e−Q
Each firm wants to maximize profits.

(a) Write down the payoff (profit) function of firm i (i=1,...,n).

(b) Consider first the case where n = 2. Draw the reaction curves of both firms
and calculate the Cournot-Nash equilibrium.

(c) Consider now the general case where n is any positive integer greater than or
equal to two. Calculate the Cournot-Nash equilibrium and the corresponding price and
industry output. What happens to these variables when the number of firms increases?
(i.e. what happens when n → ∞ ?).

4. Consider the case of two firms producing a homogeneous product and competing in
prices. Each firm has a constant marginal cost equal to $0.75. The demand function is

D(p) = 100 − p (p is price in dollars)

Firms can only charge prices that correspond to denominations of U.S. currency without 1
cent coins, so that the smallest difference between two prices is 5 cents (e.g. 10.05, i.e. 10
dollars and 5 cents is an allowed price, while 3.06 is not). When prices are equal, each
firm gets exactly one half of the total demand. Find all the Nash equilibria of this duopoly
game.

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