CLASSIC MODELS OF OLIGOPOLY

Topic Three
Solution to Homework Exercise
Assume the market demand function is P(Q)=A-bQ (where
Q=q1+q2), and the costs of production are symmetric and given
by C=cqi, where i=1,2.

1. By setting MR1=MC1, show that the best-response function for

firm 1 is:

2. Show that the equilibrium quantities are:

3. Calculate the market output and the market price.

4. Calculate the equilibrium profits for firm 1.

5. Sketch the best-response functions. On your graph, indicate

the equilibrium quantities
1. Calculation:
TR1=P x q1
 TR1=(A-bq1-bq2) x q1
TR1=Aq1-bq12-bq2 q1
𝒅TR1
𝒅q1
=MR1=A-2bq1-bq2
MR=MC
A-2bq1-bq2=c
-2bq1=-A+c+bq2
q1=(A-c)/2b- ½ q2

 q2=(A-c)/2b- ½ q1
2. Calculation:
𝑨−𝒄 𝑨−𝒄
q1= −½ − ½ q1
𝟐𝒃 𝟐𝒃
𝑨−𝒄 (𝑨−𝒄)
 q1= − + 1/4 q1
𝟐𝒃 𝟒𝒃
(𝟐𝑨−𝟐𝑪−𝑨+𝒄)
3/4q1=
𝟒𝒃
(𝑨−𝒄)
q1= x 4/3
𝟒𝒃
(𝑨−𝒄)
q1=
𝟑𝒃
𝑨−𝒄 𝑨−𝒄
 q2= −½
𝟐𝒃 𝟑𝒃
(𝟑𝑨−𝟑𝑪−𝑨+𝒄)
q2=
𝟔𝒃
(𝟐𝑨−𝟐𝑪)
q2=
𝟔𝒃
(𝑨−𝑪)
q2=
𝟑𝒃
3. Calculation:
𝑨−𝒄
Q= q1+ q2 = 2
𝟑𝒃
𝑨−𝒄
P= A-b 2
𝟑𝒃
𝑨−𝒄
P= A- 2
𝟑
(𝟑𝑨−𝟐𝑨+𝟐𝒄)
P=
𝟑
(𝑨+𝟐𝒄)
P=
𝟑

4. Calculation:
1= Pq1 - cq1
1= (P-c)q1
(𝑨+𝟐𝒄) (𝑨−𝒄)
1= −𝒄
𝟑 𝟑𝒃
𝑨+𝟐𝒄−𝟑𝒄 (𝑨−𝒄)
1=
𝟑 𝟑𝒃
(𝑨−𝒄) (𝑨−𝒄)
1=
𝟑 𝟑𝒃
𝑨−𝒄 𝟐
1=
𝟗𝒃
 q2

q1=R1(q2)

(𝑨 − 𝒄)
𝟑𝒃

q2=R2(q1)

0 (𝑨 − 𝒄) q1
𝟑𝒃
Consider the demand curves for 2 differentiated products:

Q1=64-4p1+2p2; MC1=5
Q2=50-5p2+p1; MC2=4

1. Calculate firm 1’s best response function:

1=TR-TC
1=(p1xQ1)-(5xQ1)
1=p1x(64-4p1+2p2)-5x(64-4p1+2p2)
1=64p1-4p12+2p2p1-320+20p1-10p2
1=84p1-4p12+2p2p1-320-10p2
𝒅1
=84-8p1+2p2=0
𝒅p1

-8p1=-84-2p2
p1=10.5 + 1/4p2
2. Calculate firm 2’s best response function:

2=TR-TC
2=(p2xQ2)-(4xQ2)
2=p2x(50-5p2+p1)-4x(50-5p2+p1)
2=50p2-5p22+p2p1-200+20p2-4p1
2=70p2-5p22+p2p1-200-4p1
𝒅2
=70-10p2+p1=0
𝒅p𝟐

-10p2=-70-p1
p2=7 + 1/10p1
3. Calculate firm 1’s equilibrium price:

p1=10.5 + 1/4p2
p1=10.5 + ¼(7 + 1/10p1)
p1=10.5 + 7/4 + 1/40p1
p1-1/40p1=10.5 + 7/4
39/40p1=49/4
𝟒𝟗 𝟒𝟎
p1= x
𝟒 𝟑𝟗
𝟒𝟗𝟎
p1=
𝟑𝟗
p1=𝟏𝟐. 𝟓𝟔
4. Calculate firm 2’s equilibrium price:

p2=7 + 1/10(12.56)
p2=7 + 1.256
p2=8.26

5. Draw the best-response functions. On your diagram, indicate

where the curves cut the axes, and show the equilibrium
prices.