Question 1

The inverse demand function can be easily derived from the demand function as
follows:

𝑄 = 200 − 𝑝 ⇒ 𝑝 = 200 − 𝑄 (𝑖)

In Cournot Duopoly the Market quantity Q equals the sum of the two firms’ quantities
thus:

𝑄 = 𝑄1 + 𝑄2 (𝑖𝑖)

From (i), (ii) we get that:

𝑝 = 200 − 𝑄1 − 𝑄2 (𝑖𝑖𝑖)

(a)

In order to determine the firms’ reaction functions we follow the below procedure:

The Marginal Cost (MC1) for firm 1 can be computed from the 1st derivative of the
Total Cost (TC1) function, thus:

𝑑𝑇𝐶1 𝑑(3000 + 10𝑄1 )

𝑀𝐶1 = = = 10(𝑖𝑣)
𝑑𝑄1 𝑑𝑄1

The Marginal Revenue MR1 for firm 1 can be computed from the 1st derivative of the
Total Revenue (TR1) function, thus we initially compute the TR1 as follows:

𝑇𝑅1 = 𝑄1 ∗ 𝑝 = 𝑄1 (200 − 𝑄1 − 𝑄2 ) = 200𝑄1 − 𝑄1 2 − 𝑄1 𝑄2

Thus:

𝑑𝑇𝑅1 𝑑(200𝑄1 − 𝑄1 2 − 𝑄1 𝑄2 )
𝑀𝑅1 = = = 200 − 2𝑄1 − 𝑄2 (𝑣)
𝑑𝑄1 𝑑𝑄1

At Equilibrium MC1=MR1, thus from (iv) & (v) we have that the response function
for firm 1 is:

10 = 200 − 2𝑄1 − 𝑄2 ⇔ 𝑄1 = 95 − 0,5𝑄2 (𝑣𝑖)

Repeating the above procedure for firm 2 we have:

The Marginal Cost (MC2) for firm 2 can be computed from the 1st derivative of the
Total Cost (TC2) function, thus:

𝑑𝑇𝐶2 𝑑(1500 + 40𝑄2 )

𝑀𝐶2 = = = 40(𝑣𝑖𝑖)
𝑑𝑄2 𝑑𝑄2

The Marginal Revenue MR2 for firm 2 can be computed from the 1st derivative of the
Total Revenue (TR2) function, thus we initially compute the TR2 as follows:

𝑇𝑅2 = 𝑄2 ∗ 𝑝 = 𝑄2 (200 − 𝑄1 − 𝑄2 ) = 200𝑄2 − 𝑄2 2 − 𝑄1 𝑄2 (𝑣𝑖𝑖𝑖)

Thus:

𝑑𝑇𝑅2 𝑑(200𝑄2 − 𝑄2 2 − 𝑄1 𝑄2 )
𝑀𝑅2 = = = 200 − 2𝑄2 − 𝑄1 (𝑖𝑥)
𝑑𝑄2 𝑑𝑄2

At Equilibrium MC2=MR2, thus from (vii) & (ix) we have that the response function
for firm 2 is:

40 = 200 − 2𝑄2 − 𝑄1 ⇔ 𝑄2 = 80 − 0,5𝑄1 (𝑥)

(b)

Replacing Q2 from (x) in (vi) we get that quantity for firm 1 is:

𝑄1 = 95 − 0,5(80 − 0,5𝑄1 ) ⇒ 𝑄1 ≅ 73,3

And from (x) we get that quantity for firm 2 is:

𝑄2 = 80 − 0,5 ∗ 73,3 ≅ 43,3

Based on the computed response functions above [(vi) & (x)] we can draw the
relevant diagram as follows:
 Diagram 1. Reaction Functions at Cournot Duopoly Equilibrium1

The Blue line in Diagram 1 is the graphical representations of Q1 response function

(vi), while the Red line is the graphical representation of Q2 response function (x).
The Green Dot in the Diagram 1 represents the Equilibrium point where Q1=73,3 &
Q2=43,3 as computed above.

(c)

The profit level of a firm is given from the following equation:

𝜋 = 𝑇𝑅 − 𝑇𝐶

Where TR is the Total Revenue and TC is the firm’s Total Cost. Thus, in order to
calculate each firm’s profit level we need first to compute the TR & TC for each firm
as follows.

We need first to calculate the Market’s Price:

𝑄 = 𝑄1 + 𝑄2 = 73,3 + 43,3 = 116,6 𝑡ℎ𝑢𝑠

𝑝 = 200 − 𝑄 = 200 − 116,6 = 83,4

Total Revenue for each firm is calculated as follows:

𝑇𝑅1 = 𝑄1 ∗ 𝑝 = 73,3 ∗ 83,4 = 6113,22 &

𝑇𝑅2 = 𝑄2 ∗ 𝑝 = 43,3 ∗ 83,4 = 3611,22

Total Cost for each firm is calculated as follows:

𝑇𝐶1 = 3000 + 10𝑄1 = 3000 + 10 ∗ 73,3 = 3733 &

1
All diagrams in this essay have been created using the open source program Graph 4.4.2.
 𝑇𝐶2 = 1500 + 40𝑄2 = 1500 + 40 ∗ 43,3 = 3232

Thus the profit level for each firm is calculated as follows:

𝜋1 = 𝑇𝑅1 − 𝑇𝐶1 = 6113,22 − 3733 = 2380,22 &

𝜋2 = 𝑇𝑅2 − 𝑇𝐶2 = 3611,22 − 3232 = 379,22

Consumer Surplus (CS) can be derived from the graphical representation of the
Demand Function as follows:

Diagram 2. Calculating CS from the Demand Curve

The Red line in Diagram 2 represents the Demand Function (Q = 200 – p) curve. At
equilibrium point B the consumers buy the 116,6th product at the Market Price (P1) of
83,4, thus the CS equals to the green shaded area below the Demand Curve, thus:

𝐴𝑃1 ∗ 𝑃1𝐵 116,6 ∗ 116,6

𝐶𝑆 = (𝐴𝐵𝑃1) = = = 6797,78
2 2

Question 2

(a)

Based on the table and given that, when one country can produce a unit of a good
with less labor than another country, we say that the first country has an absolute
advantage in producing that good2, we conclude that Greece has an absolute

2
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 32)
advantage in cotton production and Portugal an absolute advantage in apples
production.

(b)

Given that, trade between two countries can benefit both countries if each country
exports the goods in which it has a comparative advantage3 and a country has a
comparative advantage in producing a good if the opportunity cost of producing that
good in terms of other goods is lower in that country than it is in other countries4, in
order to be able to determine which country will export cotton and which apples we
need to determine which of them will have the comparative advantage on each of the
products.

We define 𝑎𝐿𝐴 & 𝑎𝐿𝐶 the number of hours of labor required for Greece to produce one
∗ ∗
unit of Apples & one unit of Cotton respectively. We also define 𝑎𝐿𝐴 & 𝑎𝐿𝐶 the the
number of hours of labor required for Portugal to produce one unit of Apples & one
unit of Cotton respectively.

4 1
Since the ratio 𝑎𝐿𝐴 ⁄𝑎𝐿𝐶 = 20 = 5, which is equal to the opportunity cost of Apples in
∗ ⁄ ∗ 2 1
terms of Cotton for Greece5 is higher than the ratio 𝑎𝐿𝐴 𝑎𝐿𝐶 = 32 = 16, which is

equal to the opportunity cost of Apples in terms of Cotton for Portugal, Portugal has a
Comparative Advantage in Apples thus will export Apples.

20
Since the ratio 𝑎𝐿𝐶 ⁄𝑎𝐿𝐴 = = 5, which is equal to the opportunity cost of Cotton in
4
∗ ⁄ ∗ 32
terms of Apples for Greece is lower than the ratio 𝑎𝐿𝐶 𝑎𝐿𝐴 = = 16, which is
2

equal to the opportunity cost of Cotton in terms of Apple for Portugal, Greece has a
Comparative Advantage in Cotton thus will export Cotton.

(c)

The normal result of trade is that the price of a traded good relative to that of another
good ends up somewhere in between its pretrade levels in the two countries.6 The
pretrade Cotton relative price in terms of Apples for Greece is 𝑃𝐶 ⁄𝑃𝐴 = 𝑎𝐿𝐶 ⁄𝑎𝐿𝐴 = 5

3
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 29)
4
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 29)
5
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 32)
6
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 36)
and for Portugal is 𝑃𝐶∗ ⁄𝑃𝐴∗ = 𝑎𝐿𝐶
∗ ⁄ ∗
𝑎𝐿𝐴 = 16, thus the range of world price for Cotton
will be between 5 and 16. Respectively the range of world price for Apples will be
between 1/5 and 1/16.

(d)

If labor requirements in Greek cotton production increase by 3.2 times it will be

𝑎𝐿𝐶 = 64. Based on aforementioned analysis of sub-question (b) no country will have
a comparative advantage in the production of either Cotton or Apple, thus the result
will be no trade between the two countries.

Question 3

(a)

While in autarky equilibrium, demand equals supply, Qd=Qs, thus:

For Country A we have:

120 − 20𝑃 = 20𝑃 ⇔ 𝑃 = 3 & 𝑄𝐴 = 20𝑃 = 60

While for Country B we have:

120 − 20𝑃 = 10𝑃 ⇔ 𝑃 = 4 & 𝑄𝐵 = 10𝑃 = 40

(b)

𝛥𝑄 𝑃
Demand & supply elasticities7 can be computed by the formula: 𝜀 = where
𝛥𝑃 𝑄

ΔQ/ΔP is the slope of the tangent on the corresponding curve at the point of
calculation, in our case at the point of autarky equilibrium. Additionally since the
demand and/or supply function curves are linear this ratio equals the slope of the
actual curve, which equals the multiplier of P in each of the functions.

Thus,

For country A:

𝛥𝑄 𝑃 3 𝛥𝑄 𝑃 3
|𝜀𝑑 | = = 20 = 1 & |𝜀𝑠 | = = 20 =1
𝛥𝑃 𝑄 60 𝛥𝑃 𝑄 60

7
Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 57-58)
For country B:

𝛥𝑄 𝑃 4 𝛥𝑄 𝑃 4
|𝜀𝑑 | = = 20 = 2 & |𝜀𝑠 | = = 10 =1
𝛥𝑃 𝑄 40 𝛥𝑃 𝑄 40

(c)

To calculate each country’s CS, PS & TW for the autarky case we will use the
graphical representation of Demand & Supply curves as follows.

Diagram 3. CS, PS & TW calculation using Demand & Supply Curves

Point A is the autarky point for both countries. On the left pane of Diagram 3 is
represented the autarky condition for country “a”. On the right pane that of country
“b”. The purple shaded area below the demand curve in each pane represents the CS
for each country while the yellow shaded area over the supply curve the PS. Thus, for
country a:

3 ∗ 60 3 ∗ 60
𝐶𝑆𝑎 = = 90, 𝑃𝑆𝑎 = = 90 & 𝑇𝑊𝑎 = 𝐶𝑆𝑎 + 𝑃𝑆𝑎 = 90 + 90 = 180
2 2

While for country b,

2 ∗ 40 4 ∗ 40
𝐶𝑆𝑏 = = 40, 𝑃𝑆𝑏 = = 80 & 𝑇𝑊𝑏 = 𝐶𝑆𝑏 + 𝑃𝑆𝑏 = 40 + 80 = 120
2 2

(d)

While in trade and for world price equal to 3.5, (point D for country a, point E for
country b in diagram 3) country “a” exports since the domestic price is lower than the
world price and country “b” imports since the domestic price is higher than the world
price. Each country’s produced (Qs), consumed (Qd) & traded (Qt) quantities can be
calculated as follows.

For country a:

𝑄𝑠𝑎 = 20𝑃 = 20 ∗ 3.5 = 70, 𝑄𝑑𝑎 = 120 − 20𝑃 = 120 − 20 ∗ 3.5 = 50 &

Exports: 𝑄𝑡𝑎 = 𝑄𝑠𝑎 − 𝑄𝑑𝑎 = 70 − 50 = 20

While for country b:

𝑄𝑠𝑏 = 10𝑃 = 10 ∗ 3.5 = 35, 𝑄𝑑𝑎 = 120 − 20𝑃 = 120 − 20 ∗ 3.5 = 50 &

Imports: 𝑄𝑡𝑏 = 𝑄𝑑𝑏 − 𝑄𝑠𝑏 = 50 − 35 = 15

(e)

In order to calculate the changes in each country’s consumer surplus (ΔCS), producer
surplus (ΔPS) and total welfare (ΔTW) we will use again the diagram 3 above. Thus,

For country a:

(𝐸𝐴 + 𝐷𝐵)𝐷𝐸 (60 + 50)0.5

𝛥𝐶𝑆𝑎 = 𝐸𝐴𝐵𝐷 = = = 27.5
2 2

(𝐷𝐶 + 𝐸𝐴)𝐷𝐸 (70 + 60)0.5

𝛥𝑃𝑆𝑎 = 𝐸𝐴𝐶𝐷 = = = 32.5
2 2

𝛥𝑇𝑊𝑎 = 𝛥𝑃𝑆𝑎 − 𝛥𝐶𝑆𝑎 = 32.5 − 27.5 = 5

While for country b:

(𝐸𝐶 + 𝐷𝐴)𝐷𝐸 (50 + 40)0.5

𝛥𝐶𝑆𝑏 = 𝐸𝐶𝐴𝐷 = = = 22.5
2 2

(𝐷𝐴 + 𝐸𝐵)𝐷𝐸 (40 + 35)0.5

𝛥𝑃𝑆𝑏 = 𝐸𝐵𝐴𝐷 = = = 18.75
2 2

𝛥𝑇𝑊𝑏 = 𝛥𝐶𝑆𝑏 − 𝛥𝑃𝑆𝑏 = 3.75

Question 4

(a)

While in autarky equilibrium, demand equals supply, Qd=Qs, thus:

𝑄𝑑 = 80 − 20𝑃 = 50 = 𝑄𝑠 ⇔ 𝑃 = 1.5 & 𝑄𝑑 = 80 − 20 ∗ 1.5 = 50 𝑤ℎ𝑖𝑙𝑒 𝑄𝑠 = 50

Consumer surplus (CS) can be derived from the following diagram:

Diagram 4. CS, ΔCS & DW calculation using Demand & Supply Curves

The red line in diagram 4 above represents the demand curve while the vertical green
line the supply curve which is constant. The purple shaded area in diagram 4
𝐵𝐶∗𝐴𝐵 2.5∗50
represents the consumer surplus which equals to 𝐶𝑆 = 𝐴𝐵𝐶 = = = 62.5
2 2

(b)

When the country involves in the trade of this particular commodity and the
international price Pw is 0.5 (point F on diagram 4) the country will import as soon as
the domestic price is higher than the international price. The domestic production
(Qs), consumption (Qd), imports (Qt), and change in CS (ΔCS) are computed as
follows:

For Pw=0.5, 𝑄𝑑 = 80 − 20 ∗ 0.5 = 70 while Qs=50 (always constant).

The traded quantity, quantity imported equals to:

𝑄𝑡 = 𝑄𝑑 − 𝑄𝑠 = 𝐷1 − 𝑆1 = 70 − 50 = 20

The new CS will be given by the CDF area, thus the change in CS compared to the
condition of sub-question a will be given by the blue shaded area in diagram 4,
ABFD, thus:

(𝐴𝐵 + 𝐷𝐹)𝐵𝐹 (50 + 70)1

𝛥𝐶𝑆 = 𝐴𝐵𝐹𝐷 = = = 60
2 2

(c)

Supposing that the country will now impose a tariff of 0.5 in its imports8 the new
domestic price of this specific commodity will be Pw+t=0.5+0.5=1.0 (point G on
diagram 4). The domestic production (Qs), consumption (Qd), imports (Qt), and
change in CS (ΔCS) compared to the conditions of sub-question b, are computed as
follows:

For Pw+t = 1.0, 𝑄𝑑 = 80 − 20 ∗ 1.0 = 60 while Qs=50 (always constant).

The traded quantity, quantity imported, will fall9 from point D1 to point D2 and equals
to:

𝑄𝑡 = 𝑄𝑑 − 𝑄𝑠 = 𝐷2 − 𝑆2 = 60 − 50 = 10

The new CS will be given by the CGI area, thus the change in CS compared to the
condition of sub-question b will be given by the DFGI area in diagram 4, thus:

(𝐷𝐹 + 𝐺𝐼)𝐺𝐹 (70 + 60)0.5

𝛥𝐶𝑆 = 𝐷𝐹𝐺𝐼 = = = 32.5
2 2

(d)

From diagram 4 and based on the analysis of costs and benefits of a tariff for an
importing country10 we can easily derive the tariff revenue which equals to the square
area “c” and equals to 5. Additionally the DWloss equals the area “d” equals 2.5.

8
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 190)
9
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 186)
10
Krugman P. & Obstfeld M., International Economics, 8th edn, Pearson (p. 191)