BS3572 Industrial Economics Tutorial 2 Exercise 1 Suppose that there are two rms in a market.

The inverse demand function is given by p = 150 q1 q2 where qi is output of rm i (i = 1; 2). Each rm has a constant unit cost of production equal to 30. 1. Calculate the equilibrium price, output and prot of each rm when the rms decide on their outputs simultaneously. 2. Assume now that rst rm 2 decides on its output, which rm 1 observes and then it decides on its output. Calculate the equilibrium price, output and prot of each rm. 3. Suppose now that both rms compete in the market for innitely many periods of time, and they both discount their future prots using a discount factor of = 0:6. Assume that each period the rms decide on their outputs simultaneously. Verify whether or not the following trigger strategy, common to both rms, is a Nash equilibrium of the innitely repeated game: Produce output of 30 in the rst period and continue to produce this output level if the other rm has also produced output of 30 in all previous periods. If the other rm ever produces any other output level, then produce output of 40 for the rest of the periods. Exercise 2 There are two rms in a market. The rms simultaneously decide on their prices. Firm i (i = 1; 2) faces the following demand as a function of prices: 8 if pi < pj < 150 pi 1 (150 pi ) if pi = pj Di (pi ; pj ) = : 2 0 if pi > pj 1. Argue whether or not p1 = p2 = 80 is a Nash equilibrium of this strategic situation. 2. Suppose now that each rm has a capacity constraint equal to 35. Answer the previous point with the help of diagram, which shows the residual demand of a rm when the other rm sets price equal to 80. 1

Each rm has a constant unit cost of production equal to 30.

Exercise 3 1. The Coca-Cola Company and PepsiCo, Inc. are competing in the market for cola drinks by deciding whether to set a low price, L or a high price, H . Their annual prots from sales of Coca-Cola and Pepsi are summarized in the following matrix: Pepsi Coca-Cola L H L H 20; 20 80; 5 5; 70 40; 30

What is the Nash equilibrium of the game? 2. We can reasonably assume that both companies plan to be in the market forever. Suppose every year they play the game given in the payo matrix of point 1, and they both discount their future annual prots using a discount factor of = 0:75. Can the rms sustain high prices each period as a Nash equilibrium outcome using the following trigger strategy, common to both rms: Set the price high in the rst year and keep it high as long as the other rm has also set its price high in all previous years. If the other rm ever chooses the low price, then set the price low for the rest of the game.