Question: There are two identical firms in an industry, 1 and 2, each with cost function Ci = 10Xi, i = 1,2. The industry demand curve is P = 100 - 5X where industry output, X, is the sum of the two firms' outputs (X1 + X2).
(a) If each firm makes its output decisions on the assumption that the other will not react to its choices (the Cournot assumption), what is the equilibrium output for each firm? What is the equilibrium price?
(b) Suppose that each firm takes it in turn to choose its level of output, on the assumption that the other's output level is fixed. Would the process of adjustment be stable?
(c) Suppose that firm 1 introduces a cost-saving innovation, so that its cost curve becomes C1 = 8X1. Firm 2's cost curve and the industry demand curve are unchanged. What happens to the equilibrium quantity produced by each firm and to market price?