Question

Suppose the natural gas industry consisted of only two firms. Let these firms have identical cost functions, C(q) = 40q. Assume the demand curve for the industry is given by P = 100 − Q and that each firm expects the other to behave as a Cournot competitor.

a) Calculate the Cournot-Nash equilibrium for each firm, assuming that each chooses the output level that maximizes its profits when taking its rival’s output as given. What are the profits of each firm?

b) What would be the equilibrium quantity if Firm 2 had constant marginal and average costs of $25 and Firm 1 had constant marginal and average costs of $40?

c) Assuming that both firms have the original cost function, C(q) = 40q, how much should Firm 2 be willing to invest to lower its marginal cost from 40 to 25, assuming that Firm 1 will not follow suit? How much should Firm 1 be willing to spend to reduce its marginal cost to 25, assuming that Firm 2 will have marginal costs of 25 regardless of Firm 1’s actions?

Answer 1