1) Consider two firms in Cournot competition. Market demand is given by P=10-2Q. The marginal cost of firm 1 is 2. The marginal cost of firm 2 is 4.

a) Derive reaction curves for firm 1 and firm 2.

b) Find the Cournot equilibrium.

c) What is the markup (p-c)/p of firm 1 and firm 2 in equilibrium?

d) What is the slope of residual demand for firms 1 and 2?

e) What is the residual demand elasticity for firms 1 and 2? Does the firm with larger or smaller market share have the larger residual demand elasticity? Explain.

f) Does the markup equal the inverse of residual demand elasticity for these two firms?

g) (extra credit) Suppose that firm 2 increased its output by 1 unit above its Cournot-equilibrium output and firm 1 decided to fully accommodate this increase by decreasing its output by 1 unit below its Cournot-equilibrium output. Relate firm 1's price markup to its residual demand elasticity and use this to argue that firm 1's assumed full accommodation involves producing more than it optimally should in response to firm 2's output and that firm 1 would earn more by partially accommodating firm 2's price increase instead of fully accommodating the output increase.