ECONOMICS 121A

INDUSTRIAL ORGANIZATION
SPRING QUARTER 2009
PROFESSOR REQUENA

PROBLEM SET 4

DUE: MAY 22TH

Problem 1. [Entry costs and market structure]

Consider a oligopoly is which all firms have the same size and the same costs. The
demand function is Q=(4-P)810, and the firm’s total cost function is C= 10 + 2Q.

(A) Obtain the number of firms in equilibrium (free entry equilibrium) in the market.
(B) Calculate firm’s prouction and the market price.
(C) If market size doubles, what happens to the number of firms in the new
equilibrium? Why does not the number of firms also doubles?

Problem 2 [Linear city model. Hotelling model 1929]

A population of potential consumers is distributed uniformly along a linear segment of

length equal to 1500 meters. Two salesmen compete to serve the consumers along the
segment. Salesman 1 locates to a distance of 400 meters from one of the extremes
and salesman 2 locates to a distance of 200 meters from the other extreme. The utility
that consumer j obtains of the purchase of one unit of product of salesman i is equal to
Uji = v - pi - txij where pi is the price set up by salesman i, xij is the distance between
location of the consumer j and the salesman i (i=1, 2) and t is the transport cost per unit
of distance.
(A) Calculate the demands of each salesman.
(B) Calculate the price elasticities of demand of salesman 1 with respect her own
price. ¿How does the price elasticity of demand change when the transport cost
change?
( C) Suppose that both salesman face the same unit cost of production, equal to
c=20. Obtain the reaction functions of firm 1 and firm 2.
d) Obtain the Nash equilibrium in prices.
Problem 3. [Circular city model. Salop model 1979]

The population of L consumers is distributed uniformly with density equal to 1 around a

circular lake with a circumference length of 4000 meters. Each consumer buys a unit of
product that is identical except for the location of the firm. There is a entry cost for all
new firms and equal to F=250, and unit cost of production is constant and equal to
c=20. The utility that consumer j obtains of the purchase of a unit of product of firm i is
Uji = v - pi - txij , where pi is the price set up by firm i, xij is the distance between location
of the consumer j and the firm i (i=1, 2) and t is the transport cost per unit of distance
and equal to t=10. Suppose that firms are equidistant along the circumference.
a) Calculate the demand for each firms.
b) Obtain the Nash-price equilibrium.
c) Determine the number of firms operating in the long run.