The inverse market demand for fax paper is given by P = 400 − 2Q, where Q = q1 + q2. There are two firms who produce fax paper. q1 is output of firm 1 and q2 is output of firm 2. Each firm has a unit cost of production equal to 40, and they compete in the market in quantities. That is, they can choose any quantity to produce, and they make their quantity choices simultaneously. a. Show how to derive the Cournot-Nash equilibrium to this game. What are firms’ profits in equilibrium? b. What is the monopoly output, i.e., the one that maximizes total industry profit? Why isn’t producing one-half the monopoly output a Nash equilibrium outcome?
Return to the last question, but suppose now that firm 1 has a cost advantage. Its unit cost is constant and equal to 25 whereas firm 2 still has a unit cost of 40. What is the Cournot outcome now? What are the profits for each firm?