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Price Theory<Assignment 2 { Market Power

Two rms produce a homogeneous product. Market demand for the product is given

by the equation, Qd=500000-800P

Firms 1 and 2 have marginal costs of MC 1= 65 and MC2= 120 respectively. Firms

compete by simultaneously selecting the quantity of output that they will produce for

sale in the market

Question 1:

Rearrange the demand function to nd inverse demand for this market. (2

Marks)

Question 2:

Find the residual demand function for each rm, and the corresponding

marginal revenue function. (3 Marks)

Question 3:

Find each rm’s best response function. (2 Marks)

Question 4:

Solve the best response functions simultaneously to identify the equilibrium

quantities. (3 Marks)

Question 5:

Find the equilibrium market price. (2 Marks)

Question 6:

Find the equilibrium prots of both rms. (3 Marks)

Question 7:

How much would rm 2 be willing to pay to lower its marginal cost to 65

(matching rm 1’s marginal cost). (5 Marks)

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