ECO303: Economics of Market Structure and

Competition (ECO & IT)

Assignment 3 Due: Tuesday, October 29, 2012
1. Consider a market with inverse demand curve given by P = 100Q, where
Q is the aggregate output. There are 4 rms in this market. The rst 3
have constant an identical production cost of 20 per unit. The 4th rm has
constant cost of (20 + ) per unit.
a) Find the Cournot equilibrium. Be sure to identify the values for for
which all rms cover their production cost.
b) Assume that rm 1 and rm 4 merge. Can this merger be protable if
> 0 (rm 4 is a high-cost rm)? What happens to the prots of the
non-merged rms?
c) Now suppose that in addition to the variable costs, the rms also have
to incur a xed cost F. When 2 rms merge together, the xed cost
for the merged rm is bF where 1 b 2. Derive a condition on b, F
and such that a merger between rm 1 and 4 would be protable.
2. D1 and D2 are two rms engaged in price competition in the cola market
with dierentiated products. The inverse demand curves are given by
p
1
= 25 q
1
q
2
p
2
= 25 q
2
q
1
Both companies need sugar syrup as an ingredient. The syrup market is
served by two rms U1 and U2 both with identical unit cost of 5. The syrup
made by either rm is identical.
a) Conrm that competition between U1 and U2 leads to syrup priced at
5.
b) What is the resulting equilibrium for D1 and D2 (prices, quantities,
prots).
c) Now suppose U1 and D1 merge together. Find the prot for the three
post-merger companies.
d) Do U2 and D2 have any incentive to merge together?
3. Consider an entry game with capacity choice. There are two rms, an
incumbent, and a potential entrant. The inverse demand curve is given by
P(Q) = 562Q, where Q is aggregate output. The incumbent rst chooses
capacity k which is observed by the potential entrant. If the entrant decides
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to enter, then the rms engage in quantity competition. Costs for the rms
are 18 per unit of capacity, 2 per unit of production, and F in xed costs.
Find the equilibrium.
4. Learning by doing: A monopolist produces in two time periods. Inverse
demand in each time period is given by P = 40 2q. The monopolists per
unit production cost is 6 in period 1 and 6 q
1
in period 2.
a) Find the monopolists optimal choice of output in time period.
b) Redo the above when the monopolist knows that a rival rm will enter
the market in the second period with production cost 6 per unit.
5. Reading assignment: http://bit.ly/PBIdx5 Read this article. Write
down the 3 most interesting things you picked up from here (from an eco-
nomics perspective).
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