Question

X is a monopolist of a soda source that costlessly burbles forth as much soda as X cares to bottle. It costs X $2 per gallon to bottle this soda. The inverse demand curve for X’s soda is p(y) = 20 – 0.2y, where p is the price per gallon and y is the number of gallons sold.


a) What is the profit function? Find the profit-maximizing choice of y for X.

Profit = Y(P – AC) = Y(20 – 0.2Y – 2) = Y(18 – 0.2Y) = 18Y – 0.2Y^2
MC = 2
MR = 20 – 0.4Y
2 = 20 – 0.4Y
0.4Y = 20 – 2
Y = 45


b) What price does X get per gallon of soda if he produces the profit-maximizing quantity? How much profit does he make?

P = 20 – 0.2(45) = 11
Profit = 18(45) – 0.2(45)^2 = 405


c) Suppose that X’s neighbour, Z, finds a soda source that produces soda that is just as good as X’s soda, but it costs Z $6 a bottle to get his soda out of the ground and bottle it. Total market demand for soda remains as before. Suppose that X and Z each believe that the other’s quantity decision is independent of his own. What is the Cournot equilibrium output for Z? What is the price in the Cournot equilibrium?

I don’t know how to solve for this question.

Answer 1

a) I agree
b) I agree

c) Cournot models can be tricky beasts. But in this example, I believe the soulution is easy because 1) both firms have flat MC curves and MCx < MCz. I believe firm X, in the end, will drive P down to 6 and Z will produced nothing. (I wish I had more time to work the math, but I dont).

Lotsa luck.