Question:
Suppose three identical firms are engaged in Cournot competition in quantities. They all have marginal costs equal to 40.
Market demand is given by:
P(X) = 200 - X = 200 - (x1 + x2 + x3), where P denotes price, X total quantity demanded, and xi individual demand for firms i = 1,2, and 3.
a) Explain in what type of markets Cournot type competition can occur. Write down the demand curve and marginal revenue curve for firm 1.
b) What is the first order condition for profit maximization for firm 1? Compute the optimum quantity x1* for firm 1 as a function of quantities x2 and x3.
c) Since the firms are identical, symmetrical solutions exist also for the two other firms. Use this to compute the optimum quantity produced (and sold) for each firm.
d) Compute total demand, X, and market price, P. Compute each firm's profit, πi, and the sum total of all profits.
Summary:
The details about three identical firms operating in Cournot competition are given. The demand curve with marginal revenue, profit maximization, optimum quantity, total demand and market price related questions are answered.
Answer:
(a) Cournot competition happens when firms in market compete over the quantity they can sell. Also, the output decisions must be made simultaneously.
P = 200 - x1 - x2 - x3
ð Px1 = 200x1 - x12 - x1x2- x1x3 = Total revenue curve for firm 1
ð MR = 200 -2x1 - x2 - x3 = Marginal revenue curve of firm 1
(b) The FOC is:
MR = MC
ð 200- 2x1 - x2 - x3 = 40
ð x1 = (160 - x2 - x3)/2
(c) Symmetry means that in the end result, x1 = x2 = x3
Using the above condition,
x1 = (160 - x1 - x1)/2
ð 4x1 = 160
ð x1 = 40 = x2 = x3
(d) Total demand = x1 + x2 + x3 = 120
Price = 200 - 120 = 80
π1 = π2 = π3 = 40*80 - 40*40 = 40*40 = 1600
Therefore, π1 +π2 +π3 = 3*1600 = 4800