ECON 20002
Microeconomics for ECONFIN
Week 16: Tutorial session
TB2 2024
Cournot Competition. Osborne Section 9.4
Consider the game described in Section 9.4.1 of Osborne’s book
Two firms compete in selling a good; one firm does not know the other firm’s cost
function. How does this lack of information affect the firm’s behavior?
Assume that both firms can produce the good at constant unit cost. Assume that they
both know that firm’s 1 unit cost is c, but only firm 2 knows its own unit cost; firm 1
believes that firm 2’s cost is cL with probability θ and cH with probability 1 − θ, where
0 < θ < 1 and cL < cH .
Some extra information. Assume that the inverse demand function is given by
(
a − Q if Q < a
P (Q ) =
0 if Q ≥ a
(see Exercise 56.2 Cournot’s duopoly with different costs) and assume that
cL < c < cH .
Cournot Competition. Osborne Exc. 287.1
Answer the following
1 For values of cH and cL close enough that there is a Nash equilibrium in which all
outputs are positive, find this equilibrium.
2 Comparison with perfect information Cournot
1 Compare this equilibrium with the Nash equilibrium of the game in which firm 1
know’s that firm 2’s unit cost is cL
2 Compare this equilibrium with the Nash equilibrium of the game in which firm 1
know’s that firm 2’s unit cost is cH
3 Extra analysis
1 Assume that c = cL and check how output changes with changes in cH and θ.
2 Assume that c = cH and check how output changes with changes in cH and θ.
Cournot Competition. Osborne Exc. 287.1
Answer the following
1 For values of cH and cL close enough that there is a Nash equilibrium in which all
outputs are positive, find this equilibrium.
2 Comparison with perfect information Cournot
1 Compare this equilibrium with the Nash equilibrium of the game in which firm 1
know’s that firm 2’s unit cost is cL
2 Compare this equilibrium with the Nash equilibrium of the game in which firm 1
know’s that firm 2’s unit cost is cH
3 Extra analysis
1 Assume that c = cL and check how output changes with changes in cH and θ.
2 Assume that c = cH and check how output changes with changes in cH and θ.
In red we have Problem Sets and Next week’s lecture
Best responses
Recall that an equilibrium is a best response for each players (and for each type of
player).
Best responses
Recall that an equilibrium is a best response for each players (and for each type of
player).
q1 q 2 ( cH ) q 2 ( cL )
Best responses
Recall that an equilibrium is a best response for each players (and for each type of
player).
q1 q 2 ( cH ) q 2 ( cL )
Let’s consider first player 2’s best responses when player 1 plays the quantity q 1 .
Best responses
Recall that an equilibrium is a best response for each players (and for each type of
player).
q1 q 2 ( cH ) q 2 ( cL )
Let’s consider first player 2’s best responses when player 1 plays the quantity q 1 .
Recall that the profits (concave function) are given by
πc2 (qc2 |q 1 ) = (a − (q 1 + qc2 )) × qc2 − qc2 × c = (a − (q 1 + qc2 ) − c ) × qc2
Best responses
Recall that an equilibrium is a best response for each players (and for each type of
player).
q1 q 2 ( cH ) q 2 ( cL )
Let’s consider first player 2’s best responses when player 1 plays the quantity q 1 .
Recall that the profits (concave function) are given by
πc2 (qc2 |q 1 ) = (a − (q 1 + qc2 )) × qc2 − qc2 × c = (a − (q 1 + qc2 ) − c ) × qc2
The first order condition for player 2 is
0 = (a − (q 1 + qc2 ) − c ) − qc2
Best responses
The solution to the previous equation gives:
a − c − q1
qc2∗ =
2
This means that player 2 type cH best response to player 1 is
a − cH − q 1
qc2H∗ =
2
and player 2 type cL best response to player 1 is
a − cL − q 1
qc2L∗ =
2
Best responses
Player 1, on the other hand, is playing against an uncertain competitor so she
does not really know what type she is facing.
If she is facing type cL , which occurs with probability θ, then she will be facing a
supply of qc2L
If she is facing type cH , which occurs with probability 1 − θ, then she will be facing
a supply of qc2H .
The profits are then
π 1 (q 1 |qc2L , qc2H ) = θ (a − (q 1 + qc2L )) + (1 − θ )(a − (q 1 + qc2L )) × q 1 − c × q 1
= a − q 1 − θqc2L + (1 − θ )qc2L × q 1 − c × q 1
Best responses
Because demand is linear this expression is very nice.
Let
E q 2 ≡ θqc2L + (1 − θ )qc2L
to get profits
π 1 (q 1 |qc2L , qc2H ) = a − q 1 − c − E q 2 × q 1
This is the same equation as before but with E q 2 so the best response is given
by
a − c − E q2
1∗
q =
2
Equilibrium
It follows that the equilibrium is described by the system of equations
a − cL − q 1 ∗
qc2L∗ = (1)
2
2∗ a − cH − q 1 ∗
qcH =
2
a − c − E q2
q 1∗ =
2
Using the definition of E q 2 and the best responses above we get
h i
E q 2 = θqc2L∗ + (1 − θ )qc2H∗
a − cL − q 1 ∗ a − cH − q 1 ∗
=θ + (1 − θ )
2 2
a − E c 2 − q 1∗
=
2
Equilibrium
This is the equilibrium quantity of player 1
a − 2c + E c 2
1∗
q = (2)
3
which is decreasing in its own cost and increasing in the expected cost of player 2.
What happens if θ increases?
This implies that E c 2 decreases
This is because player 2 is more likely to be low cost and hence is more likely to
produce more.
Let’s rewrite the equation (abusing linearity again)
a − 2c + cL a − 2c + cH
q 1∗ = θ + (1 − θ )
3 3
Equilibrium
Replacing player 1’s equilibrium quantity (2) in the first two lines of (1) we get
a−2c +E[c 2 ]
a − cL −
qc2L∗ = 3
2
3a − 3cL − a + 2c − E c 2
=
6
2a − 4cL + 2c + cL − E c 2
=
6
a − 2cL + c E c 2 − cL
= −
3 6
a − 2cH + c E c 2 − cH
qc2H∗ = −
3 6
Equilibrium- Comment )House keeping)
Recall that we need both quantities to be positive, so
E c 2 − cL
a − 2cL + c
0≤ −
3 6
a+c 2cL (1 − θ )
≤ − − (cH − cL )
3 3 6
2c (1 − θ ) a+c
⇒ L + ( cH − cL ) ≤
3 6 3
E c 2 − cH
a − 2cH + c
0≤ −
3 6
a+c 2cH θ ( cH − cL )
≤ − +
3 3 6
2cH θ ( cH − cL ) a+c 2c
⇒ + ≤ − H
3 6 3 3
so the last line is sufficient
Equilibrium
Prices are given by
p ∗ (cL ) = a − q 1∗ − q 2∗
a − 2c + E c 2 a − 2cL + E c 2 cL − E c 2 c − E c2
= a− − − −
3 3 6 3
2a + 2c − E c 2 a − 2cL + E c 2 c − E c2 cL − E c 2
= − − −
3 3 3 6
cL − E c cL − E c
2 2
a + c + cL
= + −
3 3 6
cL − E c
2
a + c + cL
= +
3 6
cH − E c 2
a + c + cH
p ∗ (cH ) = +
3 6
