Question

Consider a market for a homogenous good (Hobbit beer) with the following inverse demand function:

p(y) = 22 − 2y where y is total sold quantity of the beer in litres on the market and p(y) is the price it sells for. There is only one firm serving the market, Samwise beer inc. The firm’s cost function is c(y) = 4y.

a) What quantity of beer will be sold on the market? What will be the market price?

Suddenly, a new beer producing firm, The Prancing Pony, enters the market. It produces the same kind of beer as Samwise beer inc and has an identical cost function. The two firms are now faced with a problem of simultaneously deciding on how much beer to sell on the market (the inverse demand function is still the same). Since none of the two firms has access to any magic they do not know the competitor’s choice of quantity when deciding on their own quantity.

b) Derive both firms’ best response functions and draw these in a diagram.

c) What is the new equilibrium quantity of beer sold in the market and what is the equilibrium market price?

d) What are the profit levels of Samwise beer inc before and after the Prancing Pony entered the market? Explain any differences in those levels

Answer 1

Here we have used the concepts related to Monopoly and Oligopoly Market structures. With the increase in the number of firms, profit per firm decreases, price decreases and total quantity produced increases. The transition from a Monopolist to an Oligopolistic firm of Samwise Beer.inc has been witnessed here, when another firm with same cost structure, producing same kind of good, enters.