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1.
Suppose the airline industry consists of only two firms:
Firm1=American and Firm2 =Texas
Air Corp.
Let the two firms have identical cost functions:
tc
i
(x
i
) = 40x
i
.
Assume the demand
curve for the industry is given by P = 100 – X where X = x
1
+x
2
, and that each firm expects
the other to behave as a Cournot competitor.
a.
Calculate the Cournot Nash equilibrium (price, quantities, and profits) for each firm
assuming that each chooses the output level that maximizes its profits taking its rival’s
output as given.
b.
Given your answers to (a), how much should Texas Air be willing to invest to lower its
marginal cost from 40 to 25, assuming that American will not follow suit?
c.
What would be the equilibrium price and quantities if Texas Air had
constant
marginal
and average costs of 25, and American had
constant
marginal and average costs of 40?
2.
Suppose Tops and Wegmans are the only two big grocery stores in a small town. They open
their grocery store from 8 a.m. to midnight and have revenues of $4 million/year and costs of
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 Fall '06
 MASSON

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