Microeconomics Problem Set 6, Spring 2026

1. Suppose that two firms are Cournot competitors. Industry demand is given by 𝑃 = 200 − 𝑞! −
𝑞" ,where 𝑞! is the output of Firm 1 and 𝑞" is the output of Firm 2. P is the price in dollars.
Both Firm 1 and Firm 2 face constant marginal and average total costs equal to $20.

a. Solve for the Cournot price, quantity for each firm, and profits for each firm.

The derivation of Firm 1’s reaction curve is:

𝑴𝑹𝟏 = 𝟐𝟎𝟎 − 𝟐𝒒𝟏 − 𝒒𝟐

𝑴𝑹𝟏 = 𝑴𝑪𝟏 → 𝟐𝟎𝟎 − 𝟐𝒒𝟏 − 𝒒𝟐 = 𝟐𝟎 ↔ 𝒒𝟏 = 𝟗𝟎 − 𝟎. 𝟓𝒒𝟐

Since 𝑴𝑪𝟏 = 𝑴𝑪𝟐 , Firm 2’s reaction curve is symmetric to Firm 1’s, or

𝒒𝟐 = 𝟗𝟎 − 𝟎. 𝟓𝒒𝟏

Then, substituting Firm 2’s reaction function into Firm 1’s,

𝒒𝟏 = 𝟗𝟎 − 𝟎. 𝟓(𝟗𝟎 − 𝟎. 𝟓𝒒𝟏 ) ↔ 𝒒𝟏 = 𝟒𝟓 + 𝟎. 𝟐𝟓𝒒𝟏 ↔ 𝒒𝟏 = 𝟔𝟎

→ 𝒒𝟐 = 𝟗𝟎 − 𝟎. 𝟓(𝟔𝟎) = 𝟔𝟎
→ 𝑷 = 𝟐𝟎𝟎 − 𝟔𝟎 − 𝟔𝟎 = $𝟖𝟎
→ 𝝅𝟏 = 𝝅𝟐 = ($𝟖𝟎 − 𝟐𝟎) × 𝟔𝟎 = $𝟑𝟔𝟎𝟎.

b. Firm 1 is considering investing in costly technology that will enable it to reduce its costs
to $14 per unit. What is the maximum amount Firm 1 should be willing to pay for this
technology? Assume that Firm 1 can guarantee that Firm 2 will not be able to acquire it.
(Hint: Think carefully about the additional benefit to Firm 1 if they have this technology
vs if they do not)

We rework part (a) with 𝑴𝑪𝟏 = 𝟏𝟒, and figure out how much additional profit
Firm 1 will make. This is the maximum amount they will be willing to pay.

𝑴𝑹𝟏 = 𝑴𝑪𝟏 → 𝟐𝟎𝟎 − 𝟐𝒒𝟏 − 𝒒𝟐 = 𝒄 ↔ 𝒒𝟏 = 𝟗𝟑 − 𝟎. 𝟓𝒒𝟐

Firm 2’s reaction function is still

𝒒𝟐 = 𝟗𝟎 − 𝟎. 𝟓𝒒𝟏
 Then, substituting Firm 2’s reaction function into Firm 1’s,

𝒒𝟏 = 𝟗𝟑 − 𝟎. 𝟓(𝟗𝟎 − 𝟎. 𝟓𝒒𝟏 ) ↔ 𝒒𝟏 = 𝟒𝟖 + 𝟎. 𝟐𝟓𝒒𝟏 ↔ 𝒒𝟏 = 𝟔𝟒

→ 𝒒𝟐 = 𝟗𝟎 − 𝟎. 𝟓(𝟔𝟒) = 𝟓𝟖
→ 𝑷 = 𝟐𝟎𝟎 − 𝟔𝟒 − 𝟓𝟖 = $𝟕𝟖
→ 𝝅𝟏 = ($𝟕𝟖 − 𝟏𝟒) × 𝟔𝟒 = $𝟒𝟎𝟗𝟔

Since $𝟒𝟎𝟗𝟔 − 𝟑𝟔𝟎𝟎 = $𝟒𝟗𝟔, the firm would be willing to pay $496 to invest in the
technology to lower cost.

c. How does your answer to (b) change if Firm 1 knows that Firm 2 can and will invest in
the new technology at the same time Firm 1 does?

Now, Firm 2 has the same reaction function as Firm 1 in part (b), so

𝒒𝟐 = 𝟗𝟑 − 𝟎. 𝟓𝒒𝟏

Then, substituting Firm 2’s reaction function into Firm 1’s,

𝒒𝟏 = 𝟗𝟑 − 𝟎. 𝟓(𝟗𝟑 − 𝟎. 𝟓𝒒𝟏 ) ↔ 𝒒𝟏 = 𝟒𝟔. 𝟓 + 𝟎. 𝟐𝟓𝒒𝟏 ↔ 𝒒𝟏 = 𝟔𝟐

→ 𝒒𝟐 = 𝟗𝟑 − 𝟎. 𝟓(𝟔𝟐) = 𝟔𝟐
→ 𝑷 = 𝟐𝟎𝟎 − 𝟔𝟐 − 𝟔𝟐 = $𝟕𝟔
→ 𝝅𝟏 = ($𝟕𝟔 − 𝟏𝟒) × 𝟔𝟐 = $𝟑𝟖𝟒𝟒

Since $𝟑𝟖𝟒𝟒 − 𝟑𝟔𝟎𝟎 = $𝟐𝟒𝟒, Firm 1 will only be willing to pay $244 for the new
technology.

2. Two organic/nondairy/non-GMO/gluten-free emu ranchers, Bill and Ted, serve a small

metropolitan market. Bill and Ted are Cournot competitors, making a conscious decision each
year regarding how many emus to breed. The price they can charge depends on how many
emus they collectively raise, and demand in this market is given by 𝑄 = 150 – 𝑃, where 𝑄 =
𝑞% + 𝑞& , where 𝑞% and 𝑞& are the numbers of emus raised by Bill and Ted individually. P is
the price in dollars. Bill raises emus at a constant marginal and average total cost of $10; Ted
raises emus at a constant marginal and average total cost of $20.

a. Find the Cournot equilibrium price, quantity, profits, and consumer surplus.

First, we note that inverse demand is given by 𝑷 = 𝟏𝟓𝟎 − 𝑸 = 𝟏𝟓𝟎 − 𝒒𝑩 − 𝒒𝑻

Reaction function for Bill:
𝑴𝑹𝑩 = 𝟏𝟓𝟎 − 𝟐𝒒𝑩 − 𝒒𝑻
 So,
𝑴𝑹𝑩 = 𝑴𝑪𝑩 → 𝟏𝟓𝟎 − 𝟐𝒒𝑩 − 𝒒𝑻 = 𝟏𝟎 ↔ 𝟏𝟒𝟎 − 𝒒𝑻 = 𝟐𝒒𝑩 ↔ 𝒒𝑩 = 𝟕𝟎 − 𝟎. 𝟓𝒒𝑻

Reaction function for Ted:

𝑴𝑹𝑻 = 𝟏𝟓𝟎 − 𝒒𝑩 − 𝟐𝒒𝑻
So,
𝑴𝑹𝑻 = 𝑴𝑪𝑻 → 𝟏𝟓𝟎 − 𝒒𝑩 − 𝟐𝒒𝑻 = 𝟐𝟎 ↔ 𝟏𝟑𝟎 − 𝒒𝑩 = 𝟐𝒒𝑻 ↔ 𝒒𝑻 = 𝟔𝟓 − 𝟎. 𝟓𝒒𝑩

Substituting Ted’s reaction function into Bill’s,

𝒒𝑩 = 𝟕𝟎 − 𝟎. 𝟓(𝟔𝟓 − 𝟎. 𝟓𝒒𝑩 ) → 𝒒𝑩 = 𝟑𝟕. 𝟓 + 𝟎. 𝟐𝟓𝒒𝑩 → 𝒒𝑩 = 𝟓𝟎
→ 𝒒𝑻 = 𝟔𝟓 − 𝟎. 𝟓(𝟓𝟎) = 𝟒𝟎
→ 𝑸𝑪 = 𝒒𝑩 + 𝒒𝑻 = 𝟓𝟎 + 𝟒𝟎 = 𝟗𝟎
→ 𝑷𝑪 = 𝟏𝟓𝟎 − 𝟗𝟎 = $𝟔𝟎
Where I’ve subscripted Q and P with a c to denote the Cournot market quantity and
price.

Bill and Ted’s profit

𝝅𝑩 = ($𝟔𝟎 − 𝟏𝟎) × 𝟓𝟎 = $𝟐𝟓𝟎𝟎
𝝅𝑻 = ($𝟔𝟎 − 𝟐𝟎) × 𝟒𝟎 = $𝟏𝟔𝟎𝟎
Consumer Surplus
𝟏
𝑪𝑺𝑪 = ($𝟏𝟓𝟎 − 𝟔𝟎) × 𝟗𝟎 = $𝟒𝟎𝟓𝟎
𝟐

b. Suppose that Bill and Ted merge, and become a monopoly provider of emus. Further,
suppose that Ted adopts Bill’s production techniques. Find the monopoly price, quantity,
profits, and consumer surplus.

𝑴𝑹 = 𝟏𝟓𝟎 − 𝟐𝑸𝑴
𝑴𝑹 = 𝑴𝑪 → 𝟏𝟓𝟎 − 𝟐𝑸𝑴 = 𝟏𝟎𝟒
→ 𝑸𝑴 = 𝟕𝟎
→ 𝑷𝑴 = 𝟏𝟓𝟎 − 𝟕𝟎 = $𝟖𝟎
𝝅𝑴 = ($𝟖𝟎 − 𝟏𝟎) × 𝟕𝟎 = $𝟒𝟗𝟎𝟎
𝟏
𝑪𝑺𝑴 = ($𝟏𝟓𝟎 − 𝟖𝟎) × 𝟕𝟎 = $𝟐𝟒𝟓𝟎
𝟐

c. Suppose that instead of merging, Bill considers buying Ted’s operation for cash. What is
the maximum amount Bill would be willing to offer Ted to purchase his emu ranch? (For
simplicity, assume that the combined firms are only going to operate for one year.)What is
the minimum amount Ted would accept from Bill? Do you think it is possible for them to
reach a deal?
 Bill is willing to offer Ted as much as the additional profit he can earn if he has the
monopoly, 𝝅𝑴 − 𝝅𝑩 = $𝟒𝟗𝟎𝟎 − $𝟐𝟓𝟎𝟎 = $𝟐𝟒𝟎𝟎.
Ted is willing to accept a minimum of $𝟏𝟔𝟎𝟎 for his ranch since that was the profit
he would be earning in one year. Given that Bill would be willing to pay more than
that, it makes sense that they could reach an agreement with a sale price somewhere
between the two amounts.

d. Would the merger of the two ranches discussed above (either part b or part c) be good for
society or bad for society overall? Note that in this case, firm profit equals firm producer
surplus.

There are multiple ways to answer this question, but the bottom line is the increase
in industry profit from the two firms merging, $𝟒𝟗𝟎𝟎 − 𝟐𝟓𝟎𝟎 − 𝟏𝟔𝟎𝟎 = $𝟖𝟎𝟎, is
more than offset by the change in consumer surplus, $𝟐𝟒𝟓𝟎 − 𝟒𝟎𝟓𝟎 = −$𝟏𝟔𝟎𝟎,
which implies that deadweight loss increases by $800 when the industry changes from
a duopoly to a monopoly.

3. Consider a monopolistically competitive industry. A graph of demand and cost conditions for
a typical firm is depicted in the
diagram below.

a. Give an example of a
monopolistically competitive
industry and explain how your
example fits the model’s
assumptions.

Brands of cereal are one

such example. Consumers do
not view different cereals as perfect substitutes, so an individual producer is likely to
face a downward sloping demand curve. There are likely low or no barriers to entry
or exit, however, so competition drives down economic profits in the long-run.

b. What is the economic profit earned by the firm represented in the graph?

This firm is earning zero economic profit because P* is equal to ATC at Q*, which
implies 𝝅∗ = (𝑷∗ − 𝑨𝑻𝑪∗ ) × 𝑸∗ = 𝟎 × 𝑸∗ = 𝟎.

c. Do you expect any entry into or exit from this industry to occur? Explain.
 Since the representative firm is earning zero economic profit, we do not expect any
entry or exit to occur.

d. Suppose that the government reduces annual licensing fees, causing the fixed cost of the
typical firm to fall. Make appropriate shifts of all curves that might be affected. What
happens to profit?

ATC shifts down because FC are lower. P* and Q* do not change because MR and
MC have not changed, but now at Q*, ATC<P, which means profit has increased.

e. Do you expect the fall in fixed costs to cause entry into or exit from this industry?
Explain. In words, which curves will this change and how?

Because economic profit is now positive, we expect entry into the industry and for
demand and MR to shift in and become flatter, until the new demand curve is
tangent to the new ATC curve.