Homework #4: Cournot competition (10pts)

Two firms (call them A and B) compete in Cournot fashion by choosing quantity. Both

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firms have identical technologies with the following cost functions:

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The market demand is given by

1. What is firm As residual demand if firm B produces 0 units? What price would
firm A charge? (calculate)
2. What is firm As residual demand if firm B produces 6 units? What price would
firm A charge? Hint: firm A is a monopoly after 6 units are subtracted from
the demand
3. What is firm As residual demand if firm B produces Q B units?
4. What is firm As marginal revenue if firm B produces Q B units?
5. What is firm As quantity if firm B produces Q B units?
6. How much should firm B produce so that firm A would not produce anything
even if firm A did not have a fixed cost?
7. Write firm As best response function?
8. Write firm Bs best response function?
9. Draw both firms response functions on the graph below. Label axis and points
where best response functions intersect axis. Label which reaction function
belongs to which firm.
10.Solve for Cournot equilibrium quantity of each firm and the total market
quantity.
11.Solve for Cournot equilibrium price.
12.Find profits of each firm. Do you expect entry or exit in the long run?
Imagine that the government wants to subsidize firm B by offering 1 dollar subsidy

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per unit. Firm Bs cost becomes

13.Write firm Bs best response function.

14.Add firm Bs best response function to the graph below
15.Find Cournot equilibrium output per firm, total market output, market price,
and firms profits
16.Can the government tax firm Bs profit and recoup the cost of the subsidy?
a. Calculate the amount of subsidy as Subsidy=Q Bx1
b. Calculate the increase in profit by comparing profits of firm B with and
without subsidy
c. Make a conclusion

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