Question One
Consider the market for snowmobiles in Wisconsin. There are two major producers, Avalanche and
IceRunner. The demand for snowmobiles is characterized by the following equation:
P = 3400 – A – I,
where
represents the number of snowmobiles Avalanche produces and
I
represents the number of snowmobiles IceRunner produces in a year.
The two companies have the same cost structures. Each have a marginal cost that is equal to average cost equal to 400 for every level of output.
Make sure to explain clearly how you are solving the problem and show your work.
a.
This is a Cournot situation where Avalanche and IceRunner choose output simultaneously. They are building the snowmobiles in the current year and then selling them for the price determined by the market in the next year. In the Nash equilibrium identify
1) the quantities chosen by Avalanche and IceRunner,
2) the market price that will result,
3) , and the profits received by Avalanche and IceRunner.
Make sure to explain clearly how you are solving the problem and show your work. (15 points)
b.
Say that Avalanche and IceRunner decided to form a cartel. If the cartel were successful, what would be
1) the combined output,
2) the price,
3 and the combined profits
for the two companies in the snowmobile market? how you found this answer (10 points)
c.
Say Avalanche and IceRunner had made an agreement to each produce half of the combined output the successful cartel would choose. IceRunner moves first and produces exactly that amount. Do you believe that a profit maximizing Avalanche will hold to the agreement? In the course of your analysis of this decision, show what would be the profit maximizing output choice that Avalanche would make given that Avalanche has seen the output that IceRunner has produced at that point. Make sure that you explain why you choose this output (5 points)
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