University Micro Economic Questions


1. Suppose there are three firms supplying a market with a homogeneous good for which the demand curve is given by P = 50 – 6Q. Each firm has a constant marginal cost of production of 2.

(a) Assuming Cournot competition what is the profit maximising choice of output and price, assuming that all firms are able to cover their fixed costs?
(b) Explain how your answer would differ if one firm were unable to cover its fixed costs.

2. Suppose that the demand for a product in the market is given by P = 1 – Q, and is currently supplied by a profit maximising monopolist with zero marginal cost. Suppose that a new firm threatens to enter the market, and will also have a marginal cost of zero.

(a) Explain how you think the price charged by the monopolist in the face of Cournot competition.
(b) Discuss whether it can ever be part of a profit maximising strategy to drive existing firms from the market through predatory pricing.

3. Two firms produce a single product- one is the upstream supplier and it makes an essential input that is then used by the downstream supplier. Suppose there is an investment, which can either be paid for entirely by one of the firms or shared equally between them, which will produce a benefit for both in terms of increased revenues. Suppose the total cost of the investment is six units (i.e. if the investment is made this cost is incurred, but it can be either shared equally or paid entirely by one firm). Now consider two different specifications of the benefit received by each firm:

                                    Only one firm invests             Both invest

Case 1                                     5                                  6

Case 2                                     5                                  4

(a) What are the equilibrium strategies of the two firms in each case? What would be the most efficient outcome in terms of total payoffs for each case?
(b) Discuss how firms in this type of situation can overcome difficulties in co-ordinating investment decisions.

4. Suppose a firm believes that the own price elasticity of demand for its product is –2. At the current price of $25 the sales volume is 100,000 per year. The marketing manager argues that a price cut of $5 for the current year will increase profits.

(a) Explain under what conditions the marketing manager’s claim is correct?
(b) Is it ever possible to determine unambiguously whether a price cut or price rise is profitable using only elasticity data?