Question

Consider an ?-firm Cournot model with identical firms and homogeneous products; the inverse demand function, marginal costs, and fixed costs are ? = ? − ??, ?, and zero, respectively. The equilibrium price is ? ∗ = ? + ?−? ?+1 .

(a) Analyse what happens to consumer surplus, producer surplus, and total surplus as the number of firms increases. [5 marks]

(b) Discuss how your answer may differ if the firms have U-shaped cost curves. [5 marks]

Answer 1

A. As n increases, number of quantity produced in the market increases which leads to further decrease in prices which will definitely increase consumer surplus and will leads to an increase in total surplus. However producer surplus may increase decrease or remain same because the producer Surplus decreases for the existing firms but when new firms enter than they will increase the producer surplus. Thus there will be indeterminate effect on producer surplus because of constant marginal cost.

b. When there is an increase in marginal cost then the supply curve is upward sloping and addition of firms will increase the  supply and shift the supply curve to the right leading to a decrease in price and an increase in quantity. Thus consumer surplus, producer surplus and total surplus all increases when number of firms increases with U shaped cost curve