ECON 351x — Microeconomics for Business

Sample Questions Chapter 9

Spring 2022
[This version: Apr/08/2022]

The answer key is at the end of this file. The objective of this workbook is to
complement the material from class. This is not an exhaustive list of the topics or types
of questions that will appear on the exams. Students should carefully read and study the
book, the videos, all the material on Blackboard (including the homework), and their own
class notes, including all the examples, exercises, and graphs from class.

Chapter 9 Question 2:

The following table contains the possible

Question 1: actions and payoffs of players 1 and 2.

The following table contains the possible Player 2

actions and payoffs of players 1 and 2. L C R

Player 2 U 20 , 3 8 , 2 7, 4
L R Player 1

U 5 , 3 2 , 2 M 9 , 11 10 , 10 4, 9
Player 1
D 6 , 3 7 , 4 D 4 , 4 8 , 2 8, 7

This is a simultaneous move game. Find This is a simultaneous move game. Find
the pure strategy Nash equilibrium of this the pure strategy Nash equilibrium of this
game. game.
(A) (U,L) (A) (U,L)
(B) (U,R)
(B) (U,R)
(C) (D,L)
(C) (M,C)
(D) (D,R)
(D) (D,L)
(E) This game does not have a pure strategy
Nash equilibrium. (E) (D,R)

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 Question 3:

The following table contains the possible This is a simultaneous move game. In the
actions and payoffs of players 1 and 2. pure strategy Nash equilibrium of this game,
Player 1 receives a payoff
Player 2
L C R
(A) 4
U 20 , 3 8 , 2 7, 4
(B) 7
Player 1
M 4 , 9 10 , 10 4, 9 (C) 8

(D) 9
D 4 , 7 8 , 2 8, 4
(E) 5

This is a simultaneous move game. In the

Question 5:
pure strategy Nash equilibrium of this game,
Player 1 receives a payoff
Consider a simultaneous move game be-
(A) 4 tween Player 1 and Player 2. What do we
(B) 7 know about dominant strategies?

(C) 8 I - A dominant strategy is a strategy that

is optimal for a player no matter what
(D) 10 an opponent does.
(E) 20
II - If neither player has a dominant strat-
egy, then the Nash equilibrium must be
Question 4:
in mixed strategies.
The following table contains the possible III - If the Nash equilibrium has pure strate-
actions and payoffs of players 1 and 2. gies, then at least one player must have
Player 2 a dominant strategy.
L CL CR R
(A) I, II and III are true
U 2, 3 9, 2 7, 1 7, 4
Player 1 (B) I, II and III are false
MU 4, 8 1, 1 4, 8 4, 9
(C) I is true, II and III are false

MD 5, 7 8, 9 5, 4 4, 5 (D) I and II are true, III is false

(E) I and III are true, II is false

D 4, 7 8, 2 8, 4 4, 9

2
Question 6: (A) one ; zero ; one

Player 1 and Player 2 will play one round (B) zero ; one ; zero
of the following simultaneous move game: (C) zero ; zero ; zero
Player 2 (D) 1/3 ; 1/3 ; 1/3
L C R
(E) Any strategy is a best response for
U 1, 3 2, 4 5, 2 Player 1
Player 1
M 4, 2 2, 3 3, 1

D 1, 4 4, 5 3, 1

Suppose Player 2 is using a non-optimal

strategy: she plays

ˆ L with probability 30%;

ˆ C with probability 30%; and

ˆ R with probability 40%.

Given that Player 1 knows that Player 2

is using this strategy, compute the expected
utility of player 1 if he plays U.

(A) 2.9

(B) 3

(C) 2.7

(D) 2.5

(E) 2.3

Question 7:

Consider the information from the previ-

ous question. If Player 2 is using the previous
strategy, then the best response of player 1 is
to play U with probability , M with
probability , and D with probability
.

3
Question 8: Player B
L C R
Player 1 and Player 2 will play one round
of the following simultaneous move game: U 5 , 1 -4 , 2 -5 , 3
Player A
Player 2 M 2 , 3 -3 , 1 1 , 2
L C R

U 2, 3 7, 4 0, 2 D -1 , 2 2 , 3 0 , 1
Player 1
M 3, 2 2, 3 3, 1
Suppose Player B is using a non-optimal
D 1, 4 4, 5 3, 1 strategy: she plays

ˆ L with probability 50%;

Suppose Player 2 is using a non-optimal ˆ C with probability 30%; and

strategy: she plays
ˆ R with probability 20%.
ˆ L with probability 30%;
Given that Player A knows that Player B
ˆ C with probability 30%; and is using this strategy, compute the best re-
sponse (BR) of Player A. Which of the fol-
ˆ R with probability 40%. lowing statements are true?
In this case, the best response of player 1 is I - Playing U with probability 100% is a
to play U with probability , M with BR of Player A.
probability , and D with probability
. II - Playing M with probability 100% is a
BR of Player A.
(A) one ; zero ; one
III - Playing D with probability 100% is a
(B) zero ; one ; zero BR of Player A.
(C) zero ; zero ; zero
(A) I, II and III are true
(D) 1/3 ; 1/3 ; 1/3
(B) I, II and III are false
(E) Any strategy is a best response for
Player 1 (C) I and II are true, III is false

(D) I and III are true, II is false

Question 9:
(E) II and III are true, I is false
Player A and Player B will play one round
of the following simultaneous move game:

4
Question 10: Question 12:

Consider the following simultaneous move Consider the following simultaneous move
game: game:

Player 2 Player 2
L R L R

U 10 , 0 0 , 10 U 5 , 5 1 , 6
Player 1 Player 1
D 0 , 10 10 , 0 D 6 , 1 4 , 4

In this game: In this game:

I - Player 1 has no dominant strategy I - Player 1’s dominant strategy is U

II - Player 2 has no dominant strategies II - Player 2’s dominant strategy os L

III - There is no Nash Equilibrium in this III - The Nash Equilibrium of this game is
game Player 1 plays U and Player 2 plays L

(A) I and II are true, III is false (A) I, II and III are true

(B) III is true, I and II are false (B) I and II are true, III is false

(C) I, II and III are true (C) I and III are true, II is false

(D) I is true, II and III are false (D) II and III are true, I is false

(E) I, II and III are false (E) I, II and III are false

Question 11: Question 13:

The game in the previous question is an The game in the previous question is an
example of example of
(A) Battle of the Sexes (A) Battle of the Sexes

(B) Pure Coordination Game (B) Pure Coordination Game

(C) Prisoner’s Dilemma (C) Prisoner’s Dilemma

(D) Assurance (D) Assurance

(E) Matching Pennies (E) Matching Pennies

5
Question 14: Player 2
Not
Consider the following simultaneous move Confess Confess
game:
Confess x , x 20 , 0
Player 1
Player 2
L R Not
0 , 20 10 , 10
U +3 , -3 -2 , -2 Confess
Player 1
D 0 , 0 -3 , +3
(A) x = −10
(B) x = −5
This game is best described as a
game. In the equilibrium of this game, play- (C) x = 5
ers use a strategy. (D) x = 15

(A) Prisoner’s Dilemma; pure (E) x = 20

(B) Prisoner’s Dilemma; mixed Question 16:

(C) Matching Pennies; mixed Consider the following simultaneous move

game:
(D) Battle of the Sexes; pure
Player 2
(E) Battle of the Sexes; mixed L R

U 3 , 3 2 , 2
Player 1
Question 15:
D 2 , 2 3 , 3
Professor Camara is trying to write a
Game Theory question for the ECON 351
final exam. He would like to construct an This game is an example of
example of a Prisoner’s Dilemma game. He
came up with the following table containing (A) Battle of the Sexes
the possible actions and payoffs of players 1 (B) Pure Coordination Game
and 2.
However, he is having a hard time trying (C) Prisoner’s Dilemma
to choose a payoff x for each player when both
players play “confess”. For this game to be a (D) Assurance
good example of a Prisoner’s Dilemma game, (E) Matching Pennies
the missing payoff x of each player should be
.

6
Question 17: II - Players do not have a dominant strat-
egy
Consider the following simultaneous move
game: III - Because in this game players do not
have dominant strategies, in equilib-
Player 2 rium players must play a mixed strat-
L R egy

U +1 , +1 +2 , +3 (A) I, II and III are true

Player 1
(B) I and III are true, II is false
D +3 , +2 +1 , +1
(C) I and II are true, III is false

(D) II and III are true, I is false

This game is best described as a (E) I, II and III are false
game. This game has Nash equilib-
rium.
Question 19:
(A) Prisoner’s Dilemma; one

(B) Matching Pennies; one Firm 1 and Firm 2 are Cournot competi-
tors. They have the same cost function
(C) Matching Pennies; no
C1 = 16Q1
(D) Battle of the Sexes; no C2 = 16Q2 .
(E) Battle of the Sexes; more than one The market demand is

QD = 110 − 0.5P
Question 18:
Compute the equilibrium of this Cournot
Consider the following simultaneous move game. What is the price in this market?
game:
(A) P = 84
Player 2
L R (B) P = 82

(C) P = 78
U 5 , 5 4 , 6
Player 1 (D) P = 88
D 6 , 4 1 , 1
(E) P = 76

What is true about this game?

I - This game has more than one equilib-

rium

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Question 20: (B) M S1 = 52%

Firm 1 and Firm 2 are Cournot competi- (C) M S1 = 54%

tors. They have the same cost function (D) M S1 = 56%
C1 = 2Q1 (E) M S1 = 58%
C2 = 2Q2 .

The market demand is Question 23:

QD = 40 − 0.5P. Consider the following information about

the market:
Compute the equilibrium, and find the profit
Market Demand Function: QD = 53 − P.
of Firm 1.
Firm 1 Cost Function: C1 = 5Q1
Firm 2 Cost Function: C2 = 5Q2
Question 21:
a) Suppose that Firm 1 is a monopolist
Modify the market from the previous
(there is no Firm 2). Find equilibrium
question as follows. In addition to the origi-
price, quantity and profit. Compute the
nal cost, the government introduces new reg-
Lerner Index of Market Power.
ulation such that Firm 2 has to pay a $6 tax
per unit of output Q2 . Firm 1 does not have b) Now suppose Firm 2 enters the market.
to pay taxes. Compute the equilibrium of Suppose Firm 1 and Firm 2 behave as
this Cournot game, and find the new profit Cournot competitors. Compute the equi-
of Firm 1. librium price, quantities and profits of
each firm. Compute the Lerner Index of
Question 22: Market Power.

Firm 1 and Firm 2 are Cournot competi- c) Now suppose Firm 1 and Firm 2 behave
tors. They are the only producers of output as Bertrand competitors. Compute the
Q. The demand for Q is equilibrium price, quantities and profits of
each firm. Compute the Lerner Index of
QD = 780 − 2P. Market Power.
For each firm, the cost function is

C1 = 10Q1
C2 = 20Q2 .

Compute the equilibrium of this market. De-

fine the market share of Firm 1 as
Q1
M S1 = .
Q1 + Q2
What is the market share of Firm 1?
(A) M S1 = 50%

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Question 24: (A) I, II, III and IV are true

The Cournot duopoly equilibrium has (B) I, II, III and IV are false
price, total output, and (C) I and II are true, III and IV are false
consumer surplus than those of a per-
fectly competitive market. (D) I and II are false, III and IV are true

(A) lower ; lower ; higher

Question 26:
(B) lower ; higher ; higher
Firm 1 and Firm 2 are Bertrand competi-
(C) higher ; lower ; lower tors. They have the same cost function
(D) lower ; higher ; lower C1 = 10Q1
(E) higher ; higher ; lower C2 = 10Q2

The market demand is

Question 25: QD = 118 − 0.5P

Consider the following information about In the Bertrand equilibrium, each firm pro-
the market: duces units of output.

Market Demand Function: (A) Q1 = Q2 = 113

QD = 300 − P (B) Q1 = Q2 = 10

(C) Q1 = Q2 = 52.5
Cost Function of each Firm:
(D) Q1 = Q2 = 105
C = 10Q
(E) Q1 = Q2 = 56.5

Consider the four types of markets stud-

ied in class: Perfect Competition (PC), Question 27:
Bertrand duopoly (B), Cournot duopoly (C)
and Monopoly (M). Rank these markets in Using the information from the previ-
terms of equilibrium prices, total quantity ous question, compute the Lerner Index of
produced in the market, deadweight loss and Monopoly Power (L) in this market.
Lerner Index of Market Power. Which of the
following statements are true? (A) L = 0

I - PP C = PB < PC < PM (B) L = 1

(C) L = M C
II - QP C = QB > QC > QM
(D) L = AC
III - DW LP C = DW LB < DW LC < DW LM
(E) L = 0.5
IV - LP C = LB < LC < LM

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Solutions to the Questions

1: (D) (D,R).

Player 2
L R

U 5 , 3 2 , 2
Player 1
D 6 , 3 7 , 4

2: (E) (D,R).

Player 2
L C R

U 20 , 3 8 , 2 7 , 4
Player 1
M 9 , 11 10 , 10 4 , 9

D 4 , 4 8 , 2 8 , 7

3: (D) 10.

Player 2
L C R

U 20 , 3 8 , 2 7 , 4
Player 1
M 4 , 9 10 , 10 4 , 9

D 4 , 7 8 , 2 8 , 4

4: (B) 7.

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 Player 2
L CL CR R

U 2 , 3 9 , 2 7 , 1 7 , 4
Player 1
MU 4 , 8 1 , 1 4 , 8 4 , 9

MD 5 , 7 8 , 9 5 , 4 4 , 5

D 4 , 7 8 , 2 8 , 4 4 , 9

5: (C) I is true, II and III are false. I is true by definition. II and III are false: for
example, in a Battle of Sexes game, neither player has a dominant strategy, but we do have
an equilibrium in pure strategies.

6: (A) 2.9. If P1 plays U, then his expected payoff is = 0.3 × 1 + 0.3 × 2 + 0.4 × 5 = 2.9.

7: (B) zero ; one ; zero. Compute the expected payoff from each possible action of player
1:
If P1 plays U, then his expected payoff is = 0.3 × 1 + 0.3 × 2 + 0.4 × 5 = 2.9.
If P1 plays M, then his expected payoff is = 0.3 × 4 + 0.3 × 2 + 0.4 × 3 = 3.
If P1 plays D, then his expected payoff is = 0.3 × 1 + 0.3 × 4 + 0.4 × 3 = 2.7.
Therefore, action M yields a strictly higher payoff, and P1 should play M with probability
one.

8: (E) Any strategy is a best response for Player 1. Compute the expected payoff from
each possible action of player 1:
If P1 plays U, then his expected payoff is = 0.3 × 2 + 0.3 × 7 + 0.4 × 0 = 2.7.
If P1 plays M, then his expected payoff is = 0.3 × 3 + 0.3 × 2 + 0.4 × 3 = 2.7.
If P1 plays D, then his expected payoff is = 0.3 × 1 + 0.3 × 4 + 0.4 × 3 = 2.7.
Therefore, Player 1 is indifferent between all his actions (that is, all the different actions
yield the same expected payoff for Player 1).

9: (C) I and II are true, III is false. Compute the expected utility of Player A, for each one
of the possible actions:
PA expected utility if he plays U: 0.50 × (5) + 0.30 × (−4) + 0.20 × (−5) = 0.3
PA expected utility if he plays M: 0.50 × (2) + 0.30 × (−3) + 0.20 × (1) = 0.3

11
PA expected utility if he plays D: 0.50 × (−1) + 0.30 × (2) + 0.20 × (0) = 0.1
Note that U and M yield the highest payoff (0.3), while D yields a lower payoff. Therefore,
PA should play D with probability zero. What about U and M? Since both yield the same
highest payoff, the player is indifferent between ANY mix of U and M. That is, as long as
the probability of D is zero, any other strategy is a best response. The strategies below are
just a few examples of the many possible best responses:
ˆ U with probability 100%.

ˆ U with probability 60% and M with probability 40%.

ˆ U with probability 50% and M with probability 50%.

ˆ U with probability 40% and M with probability 60%.

ˆ M with probability 100%.

10: (A) I and II are true, III is false. III is false because this game does have a Nash
equilibrium in mixed strategies: Player 1 randomizes between U and D with probability 50%
each, while Player 2 randomizes between L and R with probability 50% each.

Player 2
L R

U 10 , 0 0 , 10
Player 1
D 0 , 10 10 , 0

11: (E) Matching Pennies.

12: (E) I, II and III are false. Player 1’s dominant strategy is D, Player 2’s dominant
strategy is R, and the equilibrium of this game is (D,R).

Player 2
L R

U 5 , 5 1 , 6
Player 1
D 6 , 1 4 , 4

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 13: (C) Prisoner’s Dilemma. Note how the equilibrium (D,R) in dominant strategies
yields payoff (4,4), while there is another outcome (U,L) that would benefit both players by
providing the higher payoff (5,5), but this option is not an equilibrium.

14: (A) Prisoner’s Dilemma; pure. Note how the equilibrium (U,R) in dominant strategies
yields payoff (-2,-2), while there is another outcome (D,L) that would benefit both players
by providing the higher payoff (0,0), but this option is not an equilibrium.

Player 2
L R

U +3 , -3 -2 , -2
Player 1
D 0 , 0 -3 , +3

15: (C) x = 5. To be a Prisoner’s Dilemma game, we need two conditions: confess must be
a dominant strategy, and the payoff from (confess, confess) must be lower than the payoff
from (not confess, not confess).
First, we need x > 0, so that “Confess” is a dominant strategy. If x < 0, then Player 1
would like to choose “Not Confess” if he believes Player 2 is choosing “Confess”. If x > 0,
then (Confess, Confess) is the unique Nash equilibrium.
Second, we need the Nash equilibrium (Confess, Confess) to result in a lower payoff than
(Not Confess, Not Confess). That is, we need x < 10.
Hence, it must be the case that 0 < x < 10. The only option in this range is 5.

16: (B) Pure Coordination Game. Note how there are two equilibria in pure strategies and
players are indifferent between these two equilibria.

Player 2
L R

U 3 , 3 2 , 2
Player 1
D 2 , 2 3 , 3

17: (E) Battle of the Sexes; more than one. Note that there are two equilibria in pure
strategies. One player prefers one equilibrium, while the other player prefers the other
equilibrium.

13
 Player 2
L R

U +1 , +1 +2 , +3
Player 1
D +3 , +2 +1 , +1

18: (C) I and II are true, III is false. III is false because this game has two pure strategy
equilibria, (D,L) and (U,R). So it is not true that players “must” play mixed strategies in
this game. Note that this is a Battle of the Sexes game.
Player 2
L R

U 5 , 5 4 , 6
Player 1
D 6 , 4 1 , 1

19: (A) P = 84. Find the inverse demand:

Q = 110 − 0.5P
0.5P = 110 − Q
P = 220 − 2Q
P = 220 − 2(Q1 + Q2 ) (using the fact that the total quantity is Q = Q1 + Q2 )
P = 220 − 2Q1 − 2Q2
Firm 1: Find marginal revenue of Firm 1:
REV1 = P Q1
REV1 = (220 − 2Q1 − 2Q2 )Q1
REV1 = 220Q1 − 2Q21 − 2Q2 Q1
M R1 = 220 − 4Q1 − 2Q2 .
Optimal choice of Firm 1
M R1 = M C1
220 − 4Q1 − 2Q2 = 16
Q∗1 = 51 − 0.5Q2 .
This is the best response of Firm 1.
Firm 2: Find REV2 then M R2 , find optimal choice M R2 = M C2 to obtain the best response

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Q∗2 = 51 − 0.5Q1 .
Equilibrium: We have a system of two equations and two variables:
Q∗1 = 51 − 0.5Q2
Q∗2 = 51 − 0.5Q1 .
Solve this system to find Q1 = Q2 = 34. The price is then P = 220 − 2Q1 − 2Q2 =
220 − 2 × 34 − 2 × 34 = 84.

20: The profit of Firm 1 is $338. Demand is QD = 40 − 0.5P , so inverse demand is:
QD = 40 − 0.5P
0.5P = 40 − QD
P = 80 − 2QD .
With two firms QD = Q1 + Q2 and we have P = 80 − 2Q1 − 2Q2 .
Firm 1:
Compute the marginal revenue
REV1 = P Q1
REV1 = (80 − 2Q1 − 2Q2 )Q1
REV1 = 80Q1 − 2Q21 − 2Q2 Q1
M R1 = 80 − 4Q1 − 2Q2

The optimal choice (best response function) of Firm 1 is

M R1 = M C1
80 − 4Q1 − 2Q2 = 2
78 − 2Q2 = 4Q1
Q∗1 = 19.5 − 0.5Q2
Do the same for Firm 2 to find Q∗2 = 19.5 − 0.5Q1 .
Nash Equilibrium:
In equilibrium, Q1 is a best response for Q2 and vice-versa. That is, we need to solve the
system of two equations and two variables
Q∗1 = 19.5 − 0.5Q2
Q∗2 = 19.5 − 0.5Q1
The solution is Q∗1 = 13 and Q∗2 = 13. The equilibrium price is then P = 80 − 2Q1 − 2Q2 =
80 − 2 × 13 − 2 × 13 = 28.
The profit of Firm 1 is then
Profit Firm 1 = Revenue Firm 1 − Cost Firm 1
Profit Firm 1 = P × Q1 − 2Q1
Profit Firm 1 = 28 × 13 − 2 × 13
Profit Firm 1 = 338.

15
In this question, the firms are symmetric, hence the profit of firm 2 is also $338.

21: The profit of Firm 1 is $392.

Now Firm 1 and Firm 2 have different cost functions. The cost of Firm 1 remains
C1 = 2Q1 , therefore the marginal cost is M C1 = 2. However, Firm 2 has to pay the
production cost 2Q2 and it has to pay a $6 per unit produced. That is, Firm 2 has to pay
6Q2 in taxes. Therefore, the new total cost of Firm 2 is C2 (with taxes) = 2Q2 + 6Q2 = 8Q2 .
The new marginal cost is then M C2 (with taxes) = 8. We now solve for the equilibrium,
taking into account this new marginal cost.
Demand is QD = 40 − 0.5P , so inverse demand is:
QD = 40 − 0.5P
0.5P = 40 − QD
P = 80 − 2QD .
With two firms QD = Q1 + Q2 and we have P = 80 − 2Q1 − 2Q2 .
Firm 1:
Compute the marginal revenue
REV1 = P Q1
REV1 = (80 − 2Q1 − 2Q2 )Q1
REV1 = 80Q1 − 2Q21 − 2Q2 Q1
M R1 = 80 − 4Q1 − 2Q2

The optimal choice (best response function) of Firm 1 is

M R1 = M C1
80 − 4Q1 − 2Q2 = 2
78 − 2Q2 = 4Q1
Q∗1 = 19.5 − 0.5Q2
Firm 2:
Compute the marginal revenue
REV2 = P Q2
REV2 = (80 − 2Q1 − 2Q2 )Q2
REV2 = 80Q1 − 2Q1 Q2 − 2Q22
M R2 = 80 − 2Q1 − 4Q2

The optimal choice (best response function) of Firm 2 is

M R2 = M C2 (with taxes)
80 − 2Q1 − 4Q2 = 8
72 − 2Q1 = 4Q2
Q∗2 = 18 − 0.5Q1

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Equilibrium:
In equilibrium, Q1 is a best response for Q2 and vice-versa. That is, we need to solve the
system of two equations and two variables

Q∗1 = 19.5 − 0.5Q2

Q∗2 = 18 − 0.5Q1

The solution is Q∗1 = 14 and Q∗2 = 11. Notice that, because Firm 2 now has a higher marginal
cost than Firm 1, Firm 2 in equilibrium produces less output than Firm 1. The equilibrium
price is then P = 80 − 2Q1 − 2Q2 = 80 − 2 × 14 − 2 × 11 = 30. Notice that the new price is
now higher (it was 28 in the previous question), because of the new tax on Firm 2.
The profit of Firm 1 is then

Profit Firm 1 = Revenue Firm 1 − Cost Firm 1

Profit Firm 1 = P × Q1 − 2Q1
Profit Firm 1 = 30 × 14 − 2 × 14
Profit Firm 1 = 392.

Because of the tax on Firm 2, the profit of Firm 1 increases from $338 (in the previous
question) to $392.
Extra: Compute the profit of Firm 2.

Profit Firm 2 = Revenue Firm 2 − Cost Firm 2 (including taxes)

Profit Firm 2 = P × Q2 − 8Q2
Profit Firm 2 = 30 × 11 − 8 × 11
Profit Firm 2 = 242.

Because of the tax, the profit of Firm 2 decreases from $338 (in the previous question) to $242.

22: (B) M S1 = 52%. Note that the firms have different cost functions, hence, in equilibrium,
they will produce different quantities.
Inverse demand: P = 390 − 0.5Q1 − 0.5Q2
Firm 1:

REV1 = (390 − 0.5Q1 − 0.5Q2 )Q1

M R1 = 390 − Q1 − 0.5Q2
Optimal:
M R1 = M C1
390 − Q1 − 0.5Q2 = 10
Q1 = 380 − 0.5Q2 .

17
Firm 2:

REV2 = (390 − 0.5Q1 − 0.5Q2 )Q2

M R2 = 390 − 0.5Q1 − Q2
Optimal:
M R2 = M C2
390 − 0.5Q1 − Q2 = 20
Q2 = 370 − 0.5Q1 .

To find the equilibrium, solve the system of equations

Q1 = 380 − 0.5Q2
Q2 = 370 − 0.5Q1 .

The solution is Q1 = 260 and Q2 = 240. Therefore

Q1 260
M S1 = = = 0.52
Q1 + Q2 260 + 240
Note that since Firm 1 has a lower cost, in equilibrium, it produces more units than Firm 2
and obtains a higher profit.

23: a) Monopolist: The inverse demand is P = 53 − Q. Therefore

REV= PQ
= (53 − Q)Q
= 53Q − Q2
MR = 53 − 2Q.

Profit maximization:

MR = MC
53 − 2Q = 5
Q = 24.

Using the inverse demand, the price is P = 53 − 24 = 29 and Profit = P Q − 5Q =

29 × 24 − 5 × 24 = 576.
Lerner L = P −M
P
C
= 29−5
29
= 0.83.

b) Cournot duopoly: With the two firms, the inverse demand is P = 53 − Q1 − Q2 .

Firm 1 chooses a quantity such that M R1 = M C1 . For Firm 1 we have

REV1 = P ∗ Q1
REV1 = (53 − Q1 − Q2 )Q1
REV1 = 53Q1 − Q21 − Q2 Q1
M R1 = 53 − 2Q1 − Q2 .

18
Profit maximization of Firm 1:

M R1 = M C1
53 − 2Q1 − Q2 = 5
Q1 = 24 − 0.5Q2 .

Note that Q1 = 24 − 0.5Q2 is the best response of Firm 1. Follow the same steps to find
the best response of Firm 2: Q2 = 24 − 0.5Q1 . We have a system of two equations and two
variables:

Q1 = 24 − 0.5Q2
Q2 = 24 − 0.5Q1 .

Solve for Q1 and Q2 to find the equilibrium Q1 = Q2 = 16. The price is P = 53 − Q1 − Q2 =

53 − 16 − 16 = 21. The profit of each firm is then Profit1 = P ∗ Q1 − 5Q1 = 21 × 16 − 5 × 16 =
256, Profit2 = 256, and L = P −MP
C
= 21−5
21
= 0.76.

c) Bertrand duopoly: In equilibrium, these Bertrand competitors choose P = M C.

That is, both firms choose the price P = 5. The total output is given by the demand
Q = 53 − P = 53 − 5 = 48. The two firms split the market, therefore Q1 = 24 and
Q2 = 24. The profit is Profit1 = P Q − 5Q = 5 × 24 − 5 × 24 = 0, and Profit2 = 0, with
L = P −M
P
C
= 5−5
5
= 0.
Note that the Lerner Index of Market Power is the highest when we have the monopolist,
and lowest when we have Bertrand (same outcome as perfect competition). The Cournot
competition is somewhere between.
As a general rule, keep in mind that a monopolist will choose to sell few units to keep the
price very high, which generates a high Lerner index (high market power), a lot of DWL, and
a low consumer surplus. In the opposite extreme, perfect competition (which is the same
outcome as the Bertrand competition) results in a high number of units sold at a low price
(P = M C), which generates a zero Lerner index (no market power), zero DWL (efficient
outcome), and a high consumer surplus (consumers buy more units at a lower price). The
Cournot duopoly is somewhere between the monopolist and Bertrand (perfect competition).

24: (C) higher ; lower ; lower.

As a general rule, keep in mind that a monopolist will choose to sell few units to keep the
price very high, which generates a high Lerner index (high market power), a lot of DWL, and
a low consumer surplus. In the opposite extreme, perfect competition (which is the same
outcome as the Bertrand competition) results in a high number of units sold at a low price
(P = M C), which generates a zero Lerner index (no market power), zero DWL (efficient
outcome), and a high consumer surplus (consumers buy more units at a lower price). The
Cournot duopoly is somewhere between the monopolist and Bertrand (perfect competition).

25: (A) I, II, III and IV are true. You do not need to do any computation to answer this
question. You should be able to answer the question by using what you have learned about
these different markets.

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 Perfect competition results in the highest total quantity Q and the lowest market price P,
with zero DWL (the market is efficient) and zero market power L = P −M P
C
= 0 (recall that
P = M C in perfect competition). We know that the Bertrand duopoly results in the same
outcomes as perfect competition. Moreover, the monopolist will choose the lowest quantity
to induce the highest price out of these four markets. The lowest quantity and highest price
result in the highest DWL (very inefficient market) and the highest Lerner Index (recall
that more market power is associated with a higher L). Finally, the degree of competition in
the Cournot duopoly is somewhere between perfect competition (very competitive) and the
monopoly (no competition). Therefore, the total quantity, price, DWL and Lerner index of
market power in Cournot are between PC and M.

26: (E) Q1 = Q2 = 56.5. The marginal cost of each firm is M C = 10, therefore in the
Bertrand competition each firm chooses a price P = 10. Total demand at this price is
Q = 118 − 0.5P = 118 − 0.5 × 10 = 113. The firms split the market and each firm produces
half of the total, 113
2
= 56.5.

27: (A) L = 0. Bertrand competition results in the same price as perfect competition
(P=MC), therefore L = P −M
P
C
= 0.

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