Suppose that two firms (A and B) compete in quantities (Cournot) in a market in which demand is described by P = 260-2Q. Each firm incurs no fixed cost but has a marginal cost of 20. They sell homogeneous products.

(a) The two firms choose quantity levels simultaneously and non-cooperatively. Compute equilibrium quantities, market price and profits.

(b) The two firms decide to cooperate and engage in collusion: they want to reach monopoly profits. This means that they are maximizing total industry profits, acting as a monopolist. What are equilibrium quantities, market price and profits?

c) Compare the results in parts (a) and (b) in terms of consumer surplus.

(d) Assume firms A and B play a repeated game with an infinite horizon. In order to sustain the monopoly outcome from part (b), the firms play the following trigger strategy: play cooperation (i.e. monopoly outcome) in the current period so long as the other firm has cooperated in every previous period and play the Cournot Nash equilibrium if there has ever been a deviation from the monopoly outcome. What is the probability adjusted discount factor Rp the firms should apply to the expected profits in each period in order to sustain the monopoly outcome?

e) Suppose now that the two firms compete in prices (Bertrand) and have unlimited capacity. What is the probability adjusted discount factor Rp the firms should apply to the expected profits in each period in order to sustain the monopoly outcome? [Hint: to solve this question, assume that if one firm cheats, i.e. slightly undercut its rival, it captures the entire monopoly profit.

f) Based on your answers in parts (d) and (e), is it easier to sustain a cartel under quantity or price competition? Explain the intuition behind this result.