Sub: Economics Topic: Micro Economics

Question:

Equilibrium in the oligopolistic market and the effects of a merger based on

Cournots model.
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An industry consists of three firms with identical costs C(q) 18q + q². Market
demand is Q=150 - p.

I. What is the industry equilibrium (price, output and profits) if the firms have Cournot beliefs?

II. Would it pay for Firm 1 and Firm 2 to merge, if, after the merger, the remaining firm plays
Cournot? (Hint: carefully consider if the merged firm would produce using both original firms’
plants and just those of one firm.)

III. What happens if their costs are C(q)=18q instead?

Solution:
(i)C(q)=18+q^2
P=150 – Q=150 – (q1+q2+q3)
MC1=18+2q1
MC2=18+2q2
MC2=18+2q2
TR1= 150q1 - q1^2 – q2*q1 – q3*q1
TR2= 150q2 – q2^2 – q2*q1 – q3*q2
TR3= 150q3 – q3^2 – q2*q3 – q3*q1
MR1=150 – 2*q1 – q2 – q3
MR2=150 – 2*q2 – q1– q3
MR3=150 – 2*q3 – q2 – q1
On equating MR1=MC1 and MR2=MC2 and MR3=MC3 we get q1=q2=q3=22
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 Sub: Economics Topic: Micro Economics

P= 150 – (q1+q2+q3) = 84
Profits of each firm= TR – TC=1848 – 880= 968
(ii) qm = q1+q2 output of the merged firm
TRm= 150qm – qm^2 – q3*qm
TR3= 150q3 – q3^2 – q3*qm
MRm = 150 – 2qm – q3
MR3 = 150 – 2q3 – qm
MCm=18 + 2qm MC3 = 18 + 2q3
On equating MRm=MCm and MR3=MC3 we get
qm = q3 = 26.4 and Price(P) = 97.2
Profits of both merged firm and firm 3 =
TR – TC = 2566.8 – 1172.16 = 1393.48
Therefore firm1 and firm2 individually will get
(1393.48)/2 = 696.74
This amount is less than the amount which firms 1 and 2 earned when they did not merge. So it
would not pay for them to merge.
(iii)
If C(q) = 18q then MC=18 and solving in the same manner in which we solved part(ii) we get
qm = q3 =44 and P=62
This leads to profits of each firm= 2728 – 2728 = 0
Hence no firm would like to operate.

** End of the Solution **

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