Microeconomics ADE Group AR-Workbook Academic year 2021 – 22 / 2nd

term

UNIT 6: OLIGOPOLY
Pràctiques de Microeconomia ADE

PROBLEMS FOR THE PRACTICE SESSIONS- (For discussion in class)

Exercise 6.1

Suppose that two airlines decide to collude. Analyse the game between these two
companies. Suppose that each of them can charge for tickets a high price or a low
price. If one of them charges 100 euros, it gets few profits if the other also charges
100 euros and high profits if the other charges 200 euros. On the other hand, if the
company charges 200 euros, it obtains very little profit if the other charges 100
euros and an average profit if the other also charges 200 euros.
a) Represent the matrix of results of this game.
b) What is the Nash equilibrium in this game? Explain your answer.
c) Is there an outcome that would be better than the Nash equilibrium for the two
airlines? How could it be achieved? Who would lose out if it were reached?

Exercise 6.2.
If the companies that make up a duopoly agreed on the amount they are most
interested in offering to the market, what amount would they choose? Why?
If, on the other hand, each of the companies acted on its own, would they produce
between the two a greater or lesser amount than in the previous situation?
Graphically represent and explain your answers.

Ejercicio 6.3.
Little Kona es una pequeña empresa de café que está considerando la posibilidad
de entrar en un mercado dominado por Big Brewer. Los beneficios de cada una de
ellas dependen de que entre o no la primera y de que la segunda fije un precio alto
o bajo:

Big Brewer
High price Low price
BB BB
gets €3 mill gets €1 mill
Entry Little Kona Little Kona
gets €2 mill loses €2 mill
Little
Kona BB BB
gets €7 mill gets €2 mill
Do Little Kona Little Kona
Not gets nothing gets nothing
entre

1
 Unit 1 Exercises / Oligopoly and game theory  2

Great Brew threatens Little Kona by telling her, "If you go in, we're going to set a
low price, so the best thing you can do is not get in." Do you think Little Kona should
believe the threat? Why yes or why not?

Exercise 6.4.
Suppose there are only two companies (1 and 2) that fix flat tyres in the local
market and compete in a duopoly of Cournot. The two companies repair punctures
identically, so consumers will not care about repairing the puncture in company 1 or
2. The inverse demand curve for this market is: P=100-2Q, where Q is the total
number of punctures repaired per day by the two companies, that is: Q=q1+q2. The
marginal cost of repairing a flat tyre for company 1 is 12 euros, while for company 2
it is 20 euros. We will assume that neither company has fixed costs.
a) Get the profit functions of each of the companies based on q 1 and q2.
b) Obtain the reaction curves of each of the companies.
c) How many punctures a day will each company repair in the Cournot equilibrium?
d) What will be the market price of repairing a puncture?
e) What profit will each company obtain in a day?
f) Show with graphs.

Exercise 6.5.
Consider again the two firms of the previous question.
a) a) Suppose that this market is a Stackelberg oligopoly and that company 1 is
the first to decide how many punctures to repair each day. How many
punctures a day will each company repair? What will be the market price of
repairing a puncture? How much profit will each company make per day?
b) Suppose now that the two firms, instead of competing in quantities, compete
on prices according to Bertrand's model. Determine what the price,
equilibrium amount, and profits will be if:
i. The marginal cost of repairing a puncture is equal to 12 euros in the two
companies.
ii. The marginal cost of company 1 is €12, while the marginal cost of firm
2 is €20.
iii. Represent graphically.

Exercise 6.6.
Consider a duopoly in which companies compete according to Cournot's model. The
inverse market demand curve is: P(Q)=100-Q , where Q=Q1+Q2 and the average
and marginal costs of firms are constant and equal to 40.
 Unit 1 Exercises / Oligopoly and game theory  3

a. Calculate profits would each company make?

b. How much would company 1 be willing to invest to reduce its CM from 40 to
25, assuming company 2 does not support it?
Graphically show and comment on all results.

Exercise 6.7.
Suppose two identical companies produce wood stoves and they are the only ones
on the market. Its costs are given by: C1 (q1 )=200q1 and C2 (q2) = 200q2. And the
inverse market demand curve is: P=2000-2Q, where Q =q1 + q2
a) Get the Cournot-Nash equilibrium. Calculate the profits of each company.
Show graphically.
b) Suppose that the two companies form a cartel to maximize joint profits. How
many stoves will you produce? Calculate the profits of each company. Represent
graphically.
c) Managers now note that explicit agreements to collude are illegal. Each company
must decide on its own whether to produce the amount of Cournot or that of the
cartel.

Payoffs matrix 2

(Payoff 1, Payoff 2) Cournot Cartel

Cournot
1
Cartel

Exercise 6.8.
Two companies with cost functions C1 (q1 )=5q1 and C2 (q2)= 0.5 q2 ² supply the
to the same market. If the inverse market demand function is given by
, where , find
a) The production level of each firm, the price and the profits if the companies
compete according to the Cournot model.
(b) The level of production of each undertaking, the price and the profits if the
undertakings agree to jointly maximise their profits.
Show the results with the help of graphs.
 Unit 1 Exercises / Oligopoly and game theory  4

Additional Practice Exercises

Exercise A.1 .
Compare the quantity and price of an oligopoly with those of a monopoly and those
of a competitive market.

Exercise A.2 .
Sinergy and Dinaco are the only two companies in a high-tech industry. They are
faced with the following matrix of results when deciding their research budget:

Synergy

Elevado presupuesto Bajo presupuesto

Synergy gets €20 mill. Synergy gets nothing

High Dinaco gets €30 mill

Dinaco Budget Dinaco gets €70 mill

Synergy gana 30 millones Synergy gets €40 mill.

de euros
Low Dinaco gets nothing Dinaco gets €50 mill.
Budget

a) Does Sinergy have a dominant strategy? Reason your answer.

b) Does Dinaco have a dominant strategy? Reason your answer.
c) Is there a Nash equilibrium in this scenario? Reason your answer.

Exercise A.3
Two duopolists with constant and equal marginal costs supply the same market
demand. Graphically represent the irrecoverable loss of efficiency when:
a) The duopolists agree to form a cartel (collusion).
b) The duopolists compete against the Bertrand.

Ejercicio A.4
 Unit 1 Exercises / Oligopoly and game theory  5

Explique y represente gráficamente los equilibrios de los modelos de duopolio de

Cournot y Bertrand. Indique si son equilibrios de Nash y por qué. Razone su
respuesta.
(Examen 8 de junio de 2018)
Exercise A.5
Discuss the main similarities and differences between Cournot's and Bertrand's
oligopoly models. Explain why different balances are reached.
Represent graphically. (Review of June 29, 2016)

Exercise A.6
The market for a good is supplied by two companies whose total cost functions are
given by and respectively. The inverse market demand
curve is given by: P(Q)=120-Q, where . Calculate the price, quantity, and
profits of each company in the following scenarios and indicate which would be
more efficient:
a) Companies compete on prices (Bertrand).
b) Companies compete in quantities (Cournot).
c) Companies form a cartel to maximize joint profits.
Illustrate your reply with graphs.

Exercise A.7
Consider two companies operating under conditions of constant average and
marginal costs equal to 12. The product is homogeneous and the market demand is
given by , being .
a) Calculate the Cournot equilibrium and the profit of each company.
b) Calculate Bertrand's equilibrium and the profit of each company.
c) Assume now that the two companies form a cartel to maximize the joint profit.
Calculate the balance and profit of each company.
d) Which of the above results provides a greater surplus for consumers? Use
graphs.

Exercise A.8
The market for a good is supplied by two companies whose costs are given by:
y .. The inverse market demand curve is given by
, being .
a) Calculate the price, quantity, and profit of each company if they behave as in
Cournot's model.
 Unit 1 Exercises / Oligopoly and game theory  6

b) Suppose that the undertakings form a cartel. Calculate the level of production
and the profits that each of the companies will obtain.
c) Suppose that company 2 complies with the collusion agreement but company
1 breaches it by increasing production. How much will company 1 need to
produce to maximize its profit? Calculate the profit that each of the
companies will obtain in this case.
d) Use graphs.

Exercise A.9
In a market only two firms produce a homogeneous good. You work on one of them
and are tasked with drawing up the production strategy for the coming year.
The two companies in the market have the same information and the objective of
both is the maximization of their profit.
You know:
- the inverse market demand curve of the good: P(Q)=200-2Q where
,
- the function that represents the costs of your company and the rival
company: (for i=1, 2), and
- the data in the following table, with the optimal decisions according to the
different types of competition: and the data in the following
table, with the optimal decisions according to the different types of
competition:

q1 q2 P
Bertrand 45 45 20
Cournot 30 30 80
Colusión 22,5 22,5 110

a) What is more in your company's interest to compete or cooperate with the rival
company? Keep in mind that explicit collusion agreements are illegal, so each
company must decide on its own whether or not to cooperate with its rival.
(b) What risks would your company take if you decided to choose a level of
production that indicated that you wanted to collude with the rival company?
(c) If it were decided to compete, what would you suggest: compete on prices or
compete on quantities?
d) In the event that you decide to compete in quantities, what would your company
be most interested in:
- being the first to announce your production level or
 Unit 1 Exercises / Oligopoly and game theory  7

- waiting to see what level of production the rival company chooses?