VOLUNTARY EXERCISES Perfect Competition Example 5 In a perfectly competitive market the demand function is QD = 2400 6 P where QD is quantity demanded

d and P is the price. The firms operating in this market experience the following cost function: TC = 450 10QS + 2QS 2 where TC is total costs and QS is quantity supplied. Assume the market is in equilibrium.

a) Calculate the average cost curve and find the minimal average costs? b) Find the supply curve of a single firm in the market. c) How many firms operate in this market? d) What is the market supply curve?
Price Discrimination Example 6

Assume there is a firm in the chemical industry, that produces a main good A and a by-product B. Per ton produced of good A we get a quarter of a ton of the by-product B. For simplicity we denote the quantities in units, which is one ton of good A and a quarter ton of good B. Because it is not possible to differentiate the cost of production for each good, there is just one cost function. The demand function for the two goods and the total cost function are the following: DA: DB: TC: PA = 1,000 10 QA PB = 500 8QB TC = 10,000 + 200 QT +2.5 QT2

DAdemand for good A, DBdemand for good B, TCtotal cost, QTQA+QB a) What is the function of the marginal revenues? b) Find the profit maximizing price-quantity combination.

Example 7 Cartel

In the US tennis ball market, there are two big companies which produce such balls. These companies established a cartel to optimize their profits. The two firms are pretty similar in technology used and size, so they can both produce a tennis ball at constant marginal cost of $ 0.50 per ball. Both companies have fixed costs of $ 1,000 per year. The overall demand for tennis balls in the US per year is given by the following function:

Q = 80,000 10,000 P
If the companies work together in a cartel, what are the equilibrium price, quantity, and profit per firm?

Example 8 Cournot-Nash Duopoly

Use the previous example and assume the firms started to compete now over quantities (=CournotNash Duopoly). So we can find reaction-curves, which give us the quantity produced of one firm, given the quantity offered by the other one. The reaction curves are the following: Q1 = 37,500 (Q2 / 2) Q2 = 37,500 (Q1 / 2) Find the Cournot-Nash equilibrium, which is the quantity combination where no firm has an incentive to change their production level. Calculate the equilibrium price and the profit per company as well.

Example 9 Game Theory

Construct the payoff-matrix for the following game and find the Nash-equilibrium. How would you call a strategy like I and a strategy like O? You sit opposite of another player and both of you have to write either an I or an O on a sheet of paper at the same time. Youre not allowed to show your sheet to you partner or communicate by any other meaning. If both of you write an I on the sheet, both of you will get one dollar. If both of you have an O on the sheet, youll get two dollars each, and if one has an I and one an O, the one who wrote an I will get three dollars and the one with an O doesnt get anything.

Example 10 Game Theory Sequential Game The following decision tree shows all possible outcomes of a game. Firm B wants to enter a market, which is a monopoly market served by firm A. Firm B has the first move by deciding either to enter the market or to stay out. In the case that firm B enters, firm A has announced to fight for the monopoly market by entering a price war.
fight A=20, B=-10

A
enter give in A=30, B=20

B A

stay out

A=60, B=0

What is the equilibrium outcome of this situation? How would you comment the announcement of firm A to fight for the monopoly?

Solutions Example 5

a) To get the average cost curve, just divide the total cost curve by QS TC AC = QS
AC = 450 10 + 2QS QS

dAC To find its minimum, set the dQ equal to zero. S

450 +2=0 QS 2

QS = 15 In order to get the average costs at 15 units, insert into the average cost function.

AC =

450 10 + 2 *15 = 50 15

b) The supply curve of a company is given by its marginal cost curve; therefore one just has to find the MC curve. To calculate the MC curve, just derive TC to QS.

dTC = MC = 10 + 4QS dQS

c) Since every firm will produce at its minimum average cost level and there are no profits in a perfectly competitive market, the price will equal minimum average costs. Therefore one can calculate the equilibrium quantity with the demand function.

QD = 2400 6 *50 = 2100

Every firm will produce 15 units (thats the quantity at the minimum average cost level). So there will be 140 firms in the market (2100/15). d) The market supply curve is just the horizontal sum of the marginal cost curves of the single firms. Since the assumption is a perfectly competitive market in equilibrium, all cost functions are the same and so are the marginal cost curves. To sum functions up horizontally, one has to restructure the equation to get QS solely on one side.

QS =

10 + MC 4

Because there are 140 firms in the market, one has to multiply that function by 140 to get the market supply curve:
10 + MC 4 QS = 35MC + 350 QS = 140 *

Example 6

a)

The marginal revenue curve is the horizontal sum of the two individual MR curves, as long as both are positive. If the quantity is big enough and the MR curve of one good is negative, we use the higher MR curve from that point on. MRA = 1,000 20 QA MRB = 500 16 QB
1,500 36QT if QB 31.25 MRT = 1,000 20QT if QB > 31.25

b)

MCT = 200 + 5 QT MCT = MRT 200 + 5 QT = 1,500 36 QT QT = 31.71

Since this quantity is too high to be valid at the first MR curve, it can not be the profit maximizing quantity. MCT = MRB 200 + 5 QT = 1,000 20 QB QB = 32 The profit maximizing quantity is 32 units (tons) of good A and 31.25 units (quarter of tons) of good B. The reason why the firm doesnt sell as much of good B as it produces, is that the MR would be negative, so the firm is be better off not to sell those 0.75 units.

Example 7

To optimize profits in a cartel, the companies should act like a multi-plant monopoly and split the monopoly quantity between them. The monopoly quantity and price is calculated as usual: MR = MC
Q = 80,000 10, 000 P P = 8 0.0001Q MR = 8 0.0002Q 8 0.0002Q = 0.5 Q* = 37,500 P* = 8 0.0001* 37,500 P* = 4.25

Now the two firms split up the quantity and every firm produces and sells Q1 = 37,500 / 2 = 18,750 = Q2 at a price of P 1 = P 2 = 4.25 The computation of the profit of one company is as following:

1 = 2 = ( P MC ) * Q F 1 = (4.25 0.5) *18,750 1,000 1 = 69,312.5

Example 8

In order to find the equilibrium quantity, you should insert the reaction curve of firm 2 into the reaction curve of firm 1.
Q1 = 37,500 (Q2 / 2) 37,500 (Q1 / 2) ) 2 Q1 = 37,500 18,750 + (Q1 / 4) Q1 = 37,500 ( Q1* = 25,000 By symmetry of the reaction curves, the equilibrium quantity of firm 2 is the same.

To calculate the equilibrium price, just insert the aggregate quantity into the inverse demand function. P = 8 0.0001* (Q1 + Q2 )

P = 8 0.0001* (25,000 + 25,000) P* = 3 The profit in equilibrium for one firm is the following: 1 = 2 = ( P MC ) * Q1 F

1 = (3 0.5) * 25,000 1,000 1 = 61,500

Please note, that the quantity sold is higher, and price and profits are lower in the CournotNash Duopoly model than in a cartel of both companies.

Example 9

Player 1 I Pla yer 2 I O 1\1 0\3 O 3\0 2\2

The strategy set I \ I is the unique Nash-equilibrium in this game. The strategy I is called a dominant strategy, because it is the best strategy, regardless which strategy the other player chooses. In the following, the strategy O is the dominated strategy.

Example 10

To solve this game, you have to start at the end. Find out what firm A would do in each and every strategy of firm B. If firm B would enter the market, firm A is better off to give in and compete from now on in an oligopoly market. The second step is to find the best strategy for firm B, given the strategy chosen by firm A. Since firm A would give in, the profit of firm B is definitely higher if it enters the market and doesnt stay out. Accordingly, the equilibrium will be the firm B will enter the market and firm A will give in. This means, that the announcement of firm A to fight for the monopoly position is a noncredible threat.