Microeconomics II - Problem Set 4∗
February 28, 2024
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Problem 1: Price Discrimination
Ferdinand Sludge has just written a new book. His publisher, Graw McSwill, estimates
that the demand for this book in the United States is:
Q1 = 50, 000 − 2, 000P1 ,
where P1 is the price in the U.S. measured in U.S. dollars. The demand for Sludge’s opus in
England is:
Q2 = 10, 000 − 500P2 ,
where P2 is its price in England measured in U. S. dollars. His publisher has a cost function:
C(Q) = 50, 000 + 2Q,
where Q is the total number of copies that it produces.
(a) If McSwill must charge the same price in both countries, how many copies should it
sell? What price should it charge to maximize its profits? How much will those profits be?
(b) If McSwill can charge a different price in each country and wants to maximize profits,
how many copies should it sell in the United States? What price should it charge in the
United States? How many copies should it sell in England? What price should it charge in
England? How much will its total profits be?
Problem 2: Oligopoly
Grinch is the sole owner of a mineral water spring that costlessly burbles forth as much
mineral water as Grinch cares to bottle. It costs Grinch $2 per gallon to bottle this water.
The inverse demand curve for Grinch’s mineral water is p = $20 − 0.20q, where p is the price
per gallon and q is the number of gallons sold.
(a) Write down an expression for profits as a function of q. Find the profit-maximizing
choice of q for Grinch.
(b) What price does Grinch get per gallon of mineral water if he produces the profit-
maximizing quantity? How much profit does he make?
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(c) Suppose, now, that Grinch’s neighbor, Grubb finds a mineral spring that produces
mineral water that is just as good as Grinch’s water, but that it costs Grubb $6 a bottle to
get his water out of the ground and bottle it. Total market demand for mineral water remains
as before. Suppose that Grinch and Grubb each believe that the other’s quantity decision is
independent of his own. What is the Cournot equilibrium output for Grubb? What is the
price in the Cournot equilibrium?
Problem 3: Oligopoly
The inverse market demand curve for bean sprouts is given by P (Y ) = 100 − 2Y , and
the total cost function for any firm in the industry is given by C(y) = 4y.
(a) What is the change in price for a one-unit increase in output?
(b) Suppose that two Cournot firms operate in the market. What are the reaction
functions for Firm 1 and Firm 2? If the firms were operating at the Cournot equilibrium
point, what would be the industry output and price? How much would each firm produce?
What would each firm’s profit be?
(c) Draw the two reaction curves and indicate the equilibrium point on a graph.
(d) If the two firms decided to collude, what would be the industry output and the
market price?
(e) Suppose firms produce the same amount of output under the collusive agreement.
Suppose also Firm 2 behaves according to the cartel behavior. What is Firm 1 best response
when deviating from the cartel agreement? What is the new market price? What is Firm
1’s profit from the deviation?
(f) Suppose further that Firm 2 can detect Firm 1’s deviation by looking at the market
price. Is there any strategy Firm 1 and Firm 2 can play in order to make collusion stable?
Under which condition is the collusive agreement stable?
(g) Suppose now one firm acts as a Stackelberg leader and the other firm behaves as a
follower (and firms do not collude). What would be the output produced by the leader and
the output produced by the follower at equilibrium?
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Problem 4: Oligopoly
Suppose two Bertrand firms compete on the market for good x. The total demand for
good x is given by D(p) = 50 − p. The individual demand function for firm i = 1, 2 is given
by:
D(pi ) if pi < pj ,
Di (pi , pj ) = D(p)/2 if pi = pj ,
0 if pi > pj ,
for i, j = 1, 2, and i different from j (for instance, if i = 1, then j = 2, and Di (pi , pj ) is
D1 (p1 , p2 )).
The cost functions are given by C1 (y1 ) = 4y1 , and C2 (y2 ) = y2 .
(a) If each firm were to be a monopolist, which price would it charge?
(b) What are Firm 1 and Firm 2’s reaction functions? What are the equilibrium prices
and demand functions faced by the two firms?
(c) Suppose C1 (y1 ) = 30y1 . Is there any variation in the equilibrium prices and demands
faced by the two firms?