*

I will only solve the questions that I think are more relevant for exams.

1.
Competitive rent seeking.
Two contestants are fighting for a prize that worth V. The conflict technology function which
decides their chance of winning is:
1
1 2
m
m m
F
P
F F
=
+

where P is the probability that contestant 1 will win,
1
F is the fighting effort of contestant 1,
2
F is the fighting effort of contestant 2 and m is the economies of scale in conflict
measuring the advantage that a contestant with higher fighting effort has over a contestant
with lower fighting effort. Contestant 1 faces a constant marginal cost of
1
C when investing
in fighting effort and contestant 2 faces a constant marginal cost of
2
C when investing in
fighting effort. Solve for the Nash equilibrium of the simultaneous game.

2.
Bertrand (price) and Cournot (quantity) competition.
The linear demand demand functions faced by two firms are given as
1 1 1 1 2
y a b p cp = +
2 2 2 2 1
y a b p cp = +
Assuming zero costs of production, show that quantities are alwayslower and prices higher in
Cournot competition than in Bertrand competition.
Answer:
Bertrand competition:
( )
1
1 1 1 1 1 1 1 2
1
1 1 1 2
1
1 2
1
1
max
2 0
2
p
p y p a b p cp
a b p cp
p
a cp
p
b
t
t
= = +
c
= + =
c
+
=

( )
2
2 2 2 2 2 2 2 1
2
2 2 2 1
2
2 1
2
2
max
2 0
2
p
p y p a b p cp
a b p cp
p
a cp
p
b
t
t
= = +
c
= + =
c
+
=

1 2
1
1
2 1
2
2
2 1 2
2
2 2 1
2 1
2 2
2 2 1 2 1
2
1 2 1 1 2
2
1 2 1 2
1 2 1
2
2
1 2
2
2
2 2 2
2 2 2 2 2
2 4
4 4
2
4
a cp
p
b
a cp
p
b
a a cp c
p
b b b
a a c c c
p p
b b b b b
b a ca b b c
p
b b b b
b a ca
p
b b c
+
=
+
=
| | +
+ =
|
\ .
| | | |
+ + =
| |
\ . \ .
| | +
=
|
\ .
+
=

1 2
1
1
2 1
2
2
1 2
1 1
1 1 2 1 2
2
1 2 2 1 2
1
1 2 1 2
1 2 2
1
2
1 2
2
2
2 2 2 2 2
2 4
4 4
2
4
a cp
p
b
a cp
p
b
a a c c c
p p
b b b b b
a b ca b b c
p
b b b b
a b ca
p
b b c
+
=
+
=
| | | |
+ + =
| |
\ . \ .
+
=
+
=

( )
( ) ( )
1 2 2
1
2
1 2
1 2 1
2
2
1 2
1 1 1 1 2
2 2 2 2 1
1 2 2 1 2 1
1 1 1
2 2
1 2 1 2
2
1 1 2 1 1 2 2 1 2 1
1
2
1 2
1 2 1 1 2 2
2 2 2
2 2
1 2 1 2
2
4
2
4
2 2
4 4
4 2 2
4
2 2
4 4
a b ca
p
bb c
b a ca
p
bb c
y a b p cp
y a b p cp
a b ca b a ca
y a b c
bb c bb c
a bb c b a b ca c b a ca
y
bb c
b a ca a b ca
y a b c
bb c bb c
+
=

+
=

= +
= +
+ +
= +

+ + +
=

+ +
= +

( )
( ) ( )
2
2 1 2 2 1 2 1 1 2 2
2
2
1 2
4 2 2
4
a bb c b b a ca c a b ca
y
bb c
+ + +
=

Cournot competition:

2 2 2 2 1
y a b p cp = +
( )
( )
1 1 1 1 2
1 1 2
1
1
2 2 2 2 1
2 2 1
2
2
1 1 2
2 2 2 2
1
1 2 2 1 1 2 2 1 1 2
2
1 2 2 1 1 2 2 1 1 2
2
1 2 2 2 2 1 1 1 2 1
2
1 2 2 2 1 1 1 2 1
2 1
2
y a b p cp
a y cp
p
b
y a b p cp
a y cp
p
b
a y cp
y a b p c
b
b y a b b b p c a y cp
b y a b b b p ca cy c p
b b p c p a b ca b y cy
b b c p a b ca b y cy
a b c
p
= +
+
=
= +
+
=
+
= +
= + +
= + +
= +
= +
+
=
1 1 2 1
2
1 2
a b y cy
b b c

( )
( )
2 2 1
1 1 1 1
2
2 1 1 2 1 2 1 2 2 1
2
2 1 1 2 1 2 1 2 2 1
2
1 2 1 1 1 2 2 2 1 2
2
1 2 1 1 2 2 2 1 2
1 2 2 2 1 2
1
2
1 2
a y cp
y a b p c
b
b y a b bb p c a y cp
b y a b bb p ca cy c p
bb p c p a b ca b y cy
bb c p a b ca b y cy
a b ca b y cy
p
bb c
+
= +
= + +
= + +
= +
= +
+
=

( )
( )
( )
( )
1
2
1 1 2 1 2 1 2 1 1 2
2
1 2
1
1 2 2 2 1 2
2
1 1 2
1 2 2 2
1
2
1
max
1
2 0
2
y
a b y ca y b y cy y
bb c
a b ca b y cy
y bb c
a b ca cy
y
b
t
t
= +

c
= + =
c
+
=
( )
( )
( )
( )
2
2
2 2 1 2 1 2 1 2 1 2
2
1 2
2
2 1 1 1 2 1
2
2 1 2
2 1 1 1
2
1
1
max
1
2 0
2
y
a b y ca y b y cy y
bb c
a b ca b y cy
y bb c
a b ca cy
y
b
t
t
= +

c
= + =
c
+
=

1 2 2 2
1
2
2 1 1 1
2
1
2 1 1
1 2
1 1
2 1 1 1 2 2 2
2
1 1 2
2 1 1 1 2 2
2 2
1 1 2 1 2
2
2 1 1 1 2 2 1 2
2
1 1 2 1 2
2
2
2 2
2 2 2
2 2 2 2 2
4
2 2 2 4
a b ca cy
y
b
a b ca cy
y
b
a b ca c
y y
b b
a b ca a b ca cy c
y
b b b
a b ca a b ca c c c
y y
b b b b b
a b ca a b ca bb c c
y
b b b bb
+
=
+
=
+
=
| | + +
=
|
\ .
| | | | + +
+ =
| |
\ . \ .
| | | + +
=
|
\ .
( )
( )
( ) ( )
2
2 1 1 2
1 2 2 1 2
2
1 2 1 2 1 2
2 1 1 2 1 2 2
2
2
1 2
2
4
2 2 2 2 4
2
4
a b ca b
a b ca bb c c
y
b b b b bb
a b ca b c a b ca
y
bb c
|
|
\ .
+ | | | | +
=
| |
\ . \ .
+ +
=

( )
( )
2 1 1 1
2
1
1 2 2
2 1
2 2
1 2 2 2 1 1 1
1
2 2 1
1 2 2 2 1 1 1
1
2 2 1 2 1
2
1 2 2 1
2 1 1 1 2
1
1 2 2 1 1 2
1 2 2 1
2
2 2
2 2 2
2 2 2 2 2
2
4
4 2 2 4
2
a b ca cy
y
b
a b ca c
y y
b b
a b ca a b ca cy c
y
b b b
a b ca a b ca cy c c
y
b b b b b
a b ca b
a b ca b b c c
y
b b b b b b
a b ca b c a
+
=
+
=
| | + +
=
|
\ .
| | | | + +
+ =
| |
\ . \ .
+ | | +
=
|
\ .
+
( )
2 1 1
1
2
1 2
4
b ca
y
b b c
+
=

( )
( ) ( )
( ) ( )
( )
( ) ( )
( ) ( )
( )
1, 1,
2
1 1 2 1 1 2 2 1 2 1
2
1 2
1 2 2 1 2 1 1
2
1 2
2
1 1 2 1 1 2 2 1 2 1
2
1 2
1 2 2 1 2 1 1
2
1 2
2 2
1 1 2 1 1 2 1 2 1 2 1
2
1 2
4 2 2
4
2
4
4 2 2
4
2
4
4 4 2
4
B C
y y
a b b c b a b ca c b a ca
b b c
a b ca b c a b ca
bb c
a b b c b a b ca c b a ca
b b c
a b ca b c a b ca
b b c
a b b c b a b b ca b a c c a
bb c
=
+ + +

+ +
=

+ + +

+ + +
+ =

+ +

+
( )
1 2 2 1 1
2
1 2
2
1
2
1 2
2
4
0
4
b ca c a b ca
bb c
c a
b b c
+ +
=

>

3.
Bertrand competition.
Two firms, named 1 and 2, each produce a homogeneous good whosemarket demand at a
price of p is 1-p. Firm 1s average cost is constant andequal to 0; firm 2s average cost is also
constant and equal to c>0. Thetwo firms compete by simultaneously setting prices for the
good. Firm 2sells to the entire market (and firm 1 sells nothing) if and only if its priceis lower
than firm 1s price; otherwise, firm 1 sells to the entire market andfirm 2 sells nothing.
a.
What would firm 1 charge if it is a monopolist?
b.
Let p be any price between 0 and the minimum of c and 1/2. Explainwhy there is an
equilibrium in which both firms set a price of p.
c. Can there be any other equilibria for the Bertrand competition market?

Answers:
1.
If firm 1 is monopoly, he maximizes p(1-p) which gives p=1/2.
2.
Assuming c<1/2. Then firm 1 sets P=c or P=c-e, where e is very close to zero or practically
zero. Firm 2 produces zero and firm 1 captures the whole market. Firm 1 has no incentive to
set higher price, since that will induce firm 2 to enter and divide the market. Firm 1 has no
incentive to set lower price, since that lower profits. Firm 2 produces zero and could not
lower price, since p is at or below c. Firm 2 has no incentive to set higher price, since market
share will be zero. So it is a Nash equilibrium.
3.
No. If P is higher, either firm will lower price to capture the market. If P is lower, firm 1 will
lift it up since firm 2 is already out.

4.
Cournot Competition.
Consider a market in which two firms produce a homogenous product.Market demand is
given as:
( )
100 0.5
a b
P q q = +
where
a
q and
b
q are the levels of output of firm A and firm B respectively.
The cost functions of each firm are also given as:
5
a a
TC q =
2
0.5
b b
TC q =
a.
What is the Pareto optimal price (P) and output level of each firm (
a
q and
b
q ), and what
would be the profit that each firm makes at the ParetoOptimal price and output levels?
b.
Suppose that these two firms recognize their mutual independence andagree to act in unison
in order to maximize the total profit of the industry.Both output levels are then under a single
control and the industry is, ineffect, a monopoly. What are
a
q and
b
q , market price (P)
and profit ofeach firm?
c.
Now consider the Cournot solutionwhere each firmmaximizes its profitson the assumption
that the quantity produced by its rival is invariantwithrespect to its own quantity decision.
That is, each firm maximizes its ownprofit assuming the output of the other firm is given.
Again calculate themarket price, output and profit for each firm.
d.
Compare total output, price and total profit in (a) with (b) and (c). Dothey make sense?

Answer:
a.
Pareto optimality requires that social welfare or surplus, which is sum of consumer and
producer surplus, be maximized. That is, to maximized area under demand curve and
marginal costs curves. Therefore, P=5=MC1=MC2 ,qb=5, qa=185.
b.
Monopoly sets MR=MC=5. Qa=195/2, qb=5. P=195/4.
c.
Solving firm as problem gives:
95-qa-0.5qb=0
Solving firm bs problem gives:
100-0.5qa-2qb=0.
Therefore, qb=30 and qa=80.

5.
Cournot competition and perfect competition.
Consider a homogeneous product market where demand function is
1
100
N
i
P q =

i
q is the output level of firm i and there are N identical firms in themarket. All the firms
faces a constant and marginal costs of C. Supposethe firms move simultaneously setting their
output level taking the outputlevels of other firms as given.
a.
Solve for price, quantity and profit of firm i when N = 1.
b.
Solve for price, quantity and profit of firm i when N = 2.
c.
Solve for price, quantity and profit of firm i as a function of N.
d.
Suppose there is free entry and exit in the market. Solve for the perfectcompetition price,
quantity and N.
Answer:
( )
( )
( )
( )
( )
( )
( )
( )
( )
1
1
1 2 3
100
100
100 ... ... 0
100 1 0
100
1
100
100
1
1
100
1
100
1
N
i
N
j i j
j
j N
j
j
P q
q c q
c q q q q q
q
c N q
c
q
N
c
N c q
N
N N
c q
N
N
c q
N
t
t
t
=
| |
=
|
\ .
c
= + + + + =
c
+ =

=
+
| |
=
|
+
\ .
| |
| | +
=
|
|
+
\ .
\ .
| |
| |
=
|
|
+
\ .
\ .

6.
The inverse demand function, production function and inverse labor demand function of an
isolated economy with only one homogenous product and a production function involving
only one input (labor) are
P = 100 Q
Q = 2L
W = 4L
i.
Solve for the equilibrium where the monopoly firm in this economy is also a monopsony in
the labor market.
ii.
If the government is to impose a minimum wage of 80, how will this change the equilibrium
in i.
iii.
Solve for the social optimal level of production and employment.
Answer:
a.
( ) ( )
2
max
100 2
2
100 2
100 4 0
25
12.5
75
50
Q
PQ WL
Q
Q Q Q
Q Q
Q
Q
Q
L
P
W
t
t
=
=
=
c
= =
c
=
=
=
=

Alternatively
( ) ( )
2
max
100 2 2 4
200 8
200 16 0
12.5
25
50
75
L
PQ WL
L L L L
L L
L
Q
L
Q
W
P
t
t
=
=
=
c
= =
c
=
=
=
=

b.
Now marginal cost of labor is 80 for L<=20 and marginal cost of labor is 8L for L>=20.
So set marginal cost of labor equal to marginal revenue product of labor
80=200-8L
8L=120
L=15
Q=30
W=80
P=70
c.
100 2
100
3
200
3
100
6
400
6
P MC
Q Q
Q
P
L
W
=
=
=
=
=
=

Alternatively
( )
100 2 2 2
200
6
100
3
400
3
200
3
L
L
VMP W
P MP W
L L
L
Q
W
P
=
=
=
=
=
=
=


7.
The demand function in a particular industry is of the form
2
100
q
p
=
where q is the quantity demanded and p is the price. The technology in themarket is such that
each unit can be produced at the constant cost of $5.
i.
If the industry is supplied by perfectly competitive firms, what is theequilibrium price and
industry output? What is the price elasticity of demandfaced by a single firm at this price if
the firm increases its price?
ii.
If the industry is supplied by a monopolist, what is the equilibrium priceand industry output?
What is the price elasticity of demand faced by themonopolist at this price if the
firmincreases its price?
iii.
If the industry is supplied by two identical oligopolies engaged inCournotcompetition, what
is the equilibrium price and industry output?
iv.
If the industry is supplied by two identical oligopolies engaged in Betrandcompetition, what
is the equilibrium price and industry output? Ifthere are n Bertrand oligopolies, what is the
equilibrium price and industryoutput?

8.
Choosing firms location.
In a product market with a constant regulated price P, two firms simultaneously make
decision on where to locate on their product space (in a linear city):
| |
1 2
, 0,1 l l e .
Consumers are uniformly distributed on
| |
0,1 . Each consumer at most buys one unit from
one of the firm. From product i, consumer x derives utility:
( )
i i
v x r x l P t = .
Assuming
1 2
l l < , the indifferent consumer is located at
( )
^
1 2
2
l l
x
+
= .
Find the Nash equilibriums.
9.
Agency cost
1 and 2 jointly operate a firm that produces Y which sells in a perfectly competitive
market at price P. The production function is:
1 2
Y AX X
o |
=
1s share of revenue is o and 2s share of revenue is | . 1 incurs a constant marginal
cost of
1
c when contributing to the common effort and 2 incurs a constant marginal cost
of
2
c when contributing to the common effort.
a.
Find the production efforts and profits under Nash equilibrium.
b.
Find the socially optimal production efforts and profits.

10.
Tragedy of Commons
The Straits of Malacca is teeming with fishes. A fishing ship will bring in gross revenue
of 1000-5S where S is the number of fishing ships operating in the straits. It costs 10 per
ship to operate and there is free entry and exit.
a.
Find the Nash equilibrium number of ships.
b.
Find the socially optimal number of ships.

11.
Cavalry warfare
State 1 owns a heavy cavalry force. State 2 owns a light cavalry force. The two states fight
for world hegemony. The two armies engage each other on a plain.
| |
, 0,1 x y e . 1
minimizes
( )
2
x y . 2 minimizes
( )
2
x y a . Solve for the Nash equilibriums.
12.
Offense vsDefense
State 1 is on the strategic offensive. State 2 is defending herself. Both State 1 and 2 incur a
constant marginal cost of C when fielding a military unit. They fight over a fixed prize of
value V. The conflict technology function is of the form:
1
1 1
F
P
F F
|
|
=
+

| denotes the advantage of being on the offensive. Solve for the Nash equilibriums of military
expenditures given the parameter of V, C and | .