Suppose There Are Two Firms In A Market That Each Simultaneo

Suppose there are two firms in a market that each simultaneously choose a quantity. Firm 1's quantity is q1, and firm 2's quantity is q2. Therefore the market quantity is Q = q1 + q2. The market demand curve is given by P = Q. Also, each firm has constant marginal cost equal to 16.

There are no fixed costs. The marginal revenue of the two firms are given by: MR1 = q1 - 3q2 MR2 = q1 - 6q2

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The scenario presents a duopolistic market where two firms choose their quantities simultaneously, influenced by their respective marginal revenues and costs. This game-theoretic setup can be analyzed through the Cournot model, which determines equilibrium outputs when firms compete in quantities. The equations provided facilitate deriving the best response functions, understanding strategic interactions, and exploring cooperative and non-cooperative behaviors between firms.

Part A: Deriving the Best Response Functions

The marginal revenue (MR) functions for firms 1 and 2 are given as:

MR1 = q1 - 3q2


MR2 = q1 - 6q2

In Cournot competition, each firm chooses the quantity that maximizes its profit given the other firm's choice. At equilibrium, each firm's marginal revenue equals marginal cost (MC), which is 16 here.

Setting MR = MC for each firm:

For Firm 1: q1 - 3q2 = 16


=> q1 = 16 + 3q2


For Firm 2: q1 - 6q2 = 16


=> q1 = 16 + 6q2

To express Firm 2’s best response function in terms of q2, we need to eliminate q1:

From Firm 1: q1 = 16 + 3q2


Substitute q1 into Firm 2's relation:


q1 = 16 + 6q2


But since q1=16+3q2, the best response of Firm 2 is obtained from the profit maximization condition considering q1, which yields:


q2 = (q1 - 16)/6

Thus, the best response functions are:

BR1: q1 = 16 + 3q2


BR2: q2 = (q1 - 16)/6

Part B: Graphing the Best Response Functions and Identifying Equilibrium

Graphically, the best response functions are straight lines plotted in the (q1,q2) space. The intersection point of BR1 and BR2 indicates the Cournot-Nash equilibrium.

- The first response function (BR1): q1 = 16 + 3q2, straight line with slope 3, intercept 16 on q1-axis.

- The second response function (BR2): q2 = (q1 - 16)/6, straight line with slope 1/6, intercept at q1=16 where q2=0.

Plotting these lines involves selecting a range of q2 and calculating corresponding q1 values for BR1, and vice versa for BR2. The intersection point can be found algebraically by equating the two response functions or graphically.

Setting the two equal to find the equilibrium:

From BR1: q1 = 16 + 3q2


From BR2: q2 = (q1 - 16)/6


Substitute BR2 into BR1:


q1 = 16 + 3 * [(q1 - 16)/6] = 16 + (q1 - 16)/2


Multiply both sides by 2:


2q1 = 32 + q1 - 16


q1 = 16


Using q1=16 in BR2:


q2 = (16 - 16)/6 = 0

Hence, the Cournot-Nash equilibrium is at (q1, q2) = (16, 0).

Part C: Equilibrium Quantities

At equilibrium, Firm 1 produces 16 units, and Firm 2 produces 0 units. This outcome illustrates that under the given revenue structure, Firm 1 dominates production at equilibrium.

Part D: Market Price at Equilibrium

The total market quantity Q = q1 + q2 = 16 + 0 = 16. Given the market demand P = Q, the equilibrium price is:

P = 16

Part E: Profits of Each Firm

Profit for each firm is:

π_i = (P - MC) * q_i

Since both firms face marginal cost of 16:

Firm 1 profit: π1 = (16 - 16) * 16 = 0


Firm 2 profit: π2 = (16 - 16) * 0 = 0

Despite Firm 1 producing significantly, both firms earn zero profit due to the market price equaling marginal cost, characteristic of perfectly competitive equilibrium in this setup.

Part F: Joint Profit Maximization (Cartel Formation)

If the firms form a cartel aiming to maximize total joint profits and split equally, they act as a monopolist. The total profit-maximizing quantity is where marginal revenue equals marginal cost, considering joint revenue.

The combined marginal revenue equals the sum of MR1 and MR2. The combined MR can be obtained by summing the individual MR functions or considering the total revenue R(Q) where R = PQ = QQ = Q^2, so MR = dR/dQ = 2Q.

Setting MR = MC:

2Q = 16


=> Q = 8

Each firm produces half:

q1 = q2 = Q/2 = 4

Thus, each firm produces 4 units in the cartel agreement.

Part G: Firm 1's Residual Demand when Firm 2 Splits Profit

If Firm 2 produces q2 = 4 (as per part F), the residual demand for Firm 1 is:

Q = q1 + 4

The price based on total demand:

P = Q = q1 + 4

The residual demand faced by Firm 1 is thus:

P = q1 + 4

Part H: Optimal Output for Firm 1 when Firm 2 Produces 4

Firm 1 maximizes profit by choosing q1 to maximize:

π1 = (P - MC) * q1

Given:

P = q1 + 4

and MC = 16, profit function:

π1 = (q1 + 4 - 16)  q1 = (q1 -12)  q1

Maximize by taking the derivative:

dπ1/dq1 = 2q1 - 12 = 0


=> q1 = 6

Therefore, Firm 1 should produce 6 units to maximize its profit, given Firm 2's production level of 4 units.

Conclusion

This analysis highlights the strategic behavior of firms within the Cournot framework, the implications of collusive agreements, and the incentives to deviate from cooperative strategies. The equilibrium outcomes depend heavily on the revenue structures and strategic responses, illustrating the complex interactions within duopolistic markets.

References

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