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Equilibrium Price in Oligopoly Models

This document summarizes the key steps and results of analyzing a classic model of oligopoly with symmetric firms. It shows: 1. The derivation of the best response functions for each firm as a function of the other firm's output. 2. The calculation of the equilibrium quantities and prices for each firm. 3. A graph of the best response functions with the equilibrium point indicated.

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13 views11 pages

Equilibrium Price in Oligopoly Models

This document summarizes the key steps and results of analyzing a classic model of oligopoly with symmetric firms. It shows: 1. The derivation of the best response functions for each firm as a function of the other firm's output. 2. The calculation of the equilibrium quantities and prices for each firm. 3. A graph of the best response functions with the equilibrium point indicated.

Uploaded by

ash
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.

CLASSIC MODELS OF OLIGOPOLY

Topic Three
Solution to Homework Exercise
Assume the market demand function is P(Q)=A-bQ (where
Q=q1+q2), and the costs of production are symmetric and given
by C=cqi, where i=1,2.

1. By setting MR1=MC1, show that the best-response function for


firm 1 is:

2. Show that the equilibrium quantities are:

3. Calculate the market output and the market price.

4. Calculate the equilibrium profits for firm 1.

5. Sketch the best-response functions. On your graph, indicate


the equilibrium quantities
1. Calculation:
TR1=P x q1
 TR1=(A-bq1-bq2) x q1
TR1=Aq1-bq12-bq2 q1
𝒅TR1
𝒅q1
=MR1=A-2bq1-bq2
MR=MC
A-2bq1-bq2=c
-2bq1=-A+c+bq2
q1=(A-c)/2b- ½ q2

 q2=(A-c)/2b- ½ q1
2. Calculation:
𝑨−𝒄 𝑨−𝒄
q1= −½ − ½ q1
𝟐𝒃 𝟐𝒃
𝑨−𝒄 (𝑨−𝒄)
 q1= − + 1/4 q1
𝟐𝒃 𝟒𝒃
(𝟐𝑨−𝟐𝑪−𝑨+𝒄)
3/4q1=
𝟒𝒃
(𝑨−𝒄)
q1= x 4/3
𝟒𝒃
(𝑨−𝒄)
q1=
𝟑𝒃
𝑨−𝒄 𝑨−𝒄
 q2= −½
𝟐𝒃 𝟑𝒃
(𝟑𝑨−𝟑𝑪−𝑨+𝒄)
q2=
𝟔𝒃
(𝟐𝑨−𝟐𝑪)
q2=
𝟔𝒃
(𝑨−𝑪)
q2=
𝟑𝒃
3. Calculation:
𝑨−𝒄
Q= q1+ q2 = 2
𝟑𝒃
𝑨−𝒄
P= A-b 2
𝟑𝒃
𝑨−𝒄
P= A- 2
𝟑
(𝟑𝑨−𝟐𝑨+𝟐𝒄)
P=
𝟑
(𝑨+𝟐𝒄)
P=
𝟑

4. Calculation:
1= Pq1 - cq1
1= (P-c)q1
(𝑨+𝟐𝒄) (𝑨−𝒄)
1= −𝒄
𝟑 𝟑𝒃
𝑨+𝟐𝒄−𝟑𝒄 (𝑨−𝒄)
1=
𝟑 𝟑𝒃
(𝑨−𝒄) (𝑨−𝒄)
1=
𝟑 𝟑𝒃
𝑨−𝒄 𝟐
1=
𝟗𝒃
q2

q1=R1(q2)

(𝑨 − 𝒄)
𝟑𝒃

q2=R2(q1)

0 (𝑨 − 𝒄) q1
𝟑𝒃
Consider the demand curves for 2 differentiated products:

Q1=64-4p1+2p2; MC1=5
Q2=50-5p2+p1; MC2=4

1. Calculate firm 1’s best response function:

1=TR-TC
1=(p1xQ1)-(5xQ1)
1=p1x(64-4p1+2p2)-5x(64-4p1+2p2)
1=64p1-4p12+2p2p1-320+20p1-10p2
1=84p1-4p12+2p2p1-320-10p2
𝒅1
=84-8p1+2p2=0
𝒅p1

-8p1=-84-2p2
p1=10.5 + 1/4p2
2. Calculate firm 2’s best response function:

2=TR-TC
2=(p2xQ2)-(4xQ2)
2=p2x(50-5p2+p1)-4x(50-5p2+p1)
2=50p2-5p22+p2p1-200+20p2-4p1
2=70p2-5p22+p2p1-200-4p1
𝒅2
=70-10p2+p1=0
𝒅p𝟐

-10p2=-70-p1
p2=7 + 1/10p1
3. Calculate firm 1’s equilibrium price:

p1=10.5 + 1/4p2
p1=10.5 + ¼(7 + 1/10p1)
p1=10.5 + 7/4 + 1/40p1
p1-1/40p1=10.5 + 7/4
39/40p1=49/4
𝟒𝟗 𝟒𝟎
p1= x
𝟒 𝟑𝟗
𝟒𝟗𝟎
p1=
𝟑𝟗
p1=𝟏𝟐. 𝟓𝟔
4. Calculate firm 2’s equilibrium price:

p2=7 + 1/10(12.56)
p2=7 + 1.256
p2=8.26

5. Draw the best-response functions. On your diagram, indicate


where the curves cut the axes, and show the equilibrium
prices.

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