Q1. (10 points)

Imagine a small town in which only two residents, Rochelle and Alec, own wells

that produce safe drinking water. Each week Rochelle and Alec work together to

decide how many gallons of water to pump. They bring the water to town and sell

it at whatever price the market will bear. To keep things simple, suppose that

Rochelle and Alec can pump as much water as they want without any cost so that

the total and marginal and total costs of water equal zero (TC=MC=0). The town 's market demand curve is QD = 1200 - 20*PD and the potential monopolist's marginal curve corresponding to this demand curve is given as MR = 60 - (1/10)*Q. With this information, answer the questions Q1-A ~ Q1-G.

Q1-A. What is the socially efficient quantity of water?

( )

Q1-B. If Rochelle and Alec operate as a profit-maximizing monopoly in the market

for water, what will be the monopoly's equilibrium price and quantity?

Q1-C. If Rochelle and Alec operate as a profit-maximizing monopoly in the market

for water, how much profit will each of them earn, assuming that the two producers

split the market equally?

( )

Q1-D. Suppose the town enacts new antitrust laws that prohibit Rochelle and Alec

from operating as a monopoly. Now Rochelle and Alec are in an oligopoly. Let's say QR is the water quantity Rochelle produces, while QA is the water quantity Alec produces. Then, fill the blanks to derive Rochelle's best response function against

Alec's producing water quantity, and Alec's best response function against

Rochelle's producing water quantity.

(Hint: Note that MRR = 60 - (1/10)*QR - (1/20)*QA, MRA = 60 - (1/10)*QA - (1/20)*QR)

(Hint: Use the Cournot model you learned)

QR = ( ) + ( )*QA

QA = ( ) + ( )*QR

Q1-E. What will be the oligopoly equilibrium price of water, once Rochelle and Alec

reach a Nash equilibrium in the oligopoly?

( )

Q1-F. How many gallons of water will be produced and sold in total in this town,

once Rochelle and Alec reach a Nash equilibrium in the oligopoly?

( )

Q1-G. Given the answers above, compare the efficiencies among the perfectly

competitive, monopoly, and oligopoly markets.

Q2. (2 points)

Suppose that Bieber and Rihanna are duopolists in the music industry. In May, they

agree to work together as a monopolist, charging the monopoly price for their

music and producing the monopoly quantity of songs. By June, each singer is

considering breaking the agreement. What would you expect to happen next?

a. Bieber and Rihanna will determine that it is in each singer's self-interest to

maintain the agreement.

b. Bieber and Rihanna will each break the agreement. Both singers' profits will

decrease.

c. Bieber and Rihanna will each break the agreement. Both singers' profits will

increase.

d. Bieber and Rihanna will each break the agreement. The new equilibrium

quantity of songs will increase, and the new equilibrium price also will increase.

Q3. (2 points)

As the number of firms in an oligopoly increases, the magnitude of the ... ( )

a. output effect increases.

b. output effect decreases.

c. price effect increases.

d. price effect decreases.