2. Consider an industry with two firms each selling a homogeneous good and produ

Question

2. Consider an industry with two firms each selling a homogeneous good and producing at MC1 = 10 and MC2 = 40. Industry demand is given by P = 100 – Q. Competition in the market place is in quantities (Cournot competition). a. Find the equilibrium quantities, price and profits. b. Consider now a proposed merger between the two firms, resulting in a monopoly producing at MC = 10. Find the post-merger equilibrium quantities, price and profit. c. Would Competition Bureau approve the proposed merger or reject it? Provide an economic analysis to support your answer and illustrate it by a diagram.

Explanation / Answer

Let the output of two firms be q1 and q2 therefore, Q = q1 and q2

a. MR1 = 100 - 2q1 - q2

MR2 = 100 - q1 - 2q2

MC1 = 10 and MC2 = 40

for cournot equilibrium, we have to equate MR with MC, we get

100 - 2q1 - q2 = 10

q1 = (90 - q2) / 2 ........... (1)

100 - q1 - 2q2 = 40

q2 = (60 - q1) / 2 ........ (2)

Solving equation (1) and (2), we get

q1 = 40 and q2 = 10 , therefore Q = 40 + 10 = 50

P = 100 - 40 - 10 = 50

Profit of firm 1 = P * q1 - 10 * q1 = (50 - 10) * 40 = 1600

Profit of firm 2 = P * q2 - 40 * q2 = (50 - 40) * 10 = 100

Total profit of the industry = 1600 + 100 = 1700

b. When two firms collude and produces as monopolist with MC = 10, we have

MR = 100 - 2Q

equating it with MC, we get

100 - 2Q = 10

Q = 45

P = 100 - 45 = 55

Profit of monopolist = (55 * 45) - (10 * 45) = 2025

c. No the competition bureau will not approve the proposed merger as this will reduce the production whereas prices will be increased and the resultant profit of the monopolized firms will increased from 1700 to 2025. This will distort the market.

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