Econ. 359: Industrial Organization
Spring 2008
Problem Set Number 3
Due February 11, 2008
Two neighboring gasoline stations -- station A and station
B -- are competing for a limited local market. Consumers consider gasoline
from the two stations to be perfect substitutes, so a station that charges
more than the other will lose all its business. If they charge the same price,
consumers will split their purchases equally between the two stations. Demand
for gasoline from the two stations combined is 10,000 gallons per day at
a price of $3.00 per gallon. For every $0.01 per gallon the price rises above
$3.00, the quantity consumers want to buy drops by 200 gallons per day, so
that demand drops to zero at a price of $3.50 per gallon. Both stations have
a constant marginal cost, including the wholesale cost of fuel, of $3.00
per gallon. Each station also has fixed costs of $200 per day.
1. Initially, the stations compete against each other to sell the most gasoline
(maximize market share) while still covering total costs, including fixed
costs. What is the price charged and quantity sold by each firm?
2. Now, the station managers agree at their monthly Big Wheels Club meeting
to stop competing against each other and instead cooperate to maximize joint
profits. What price will they decide to charge, and how much gasoline does
each station sell. How much profit will each earn?
3. Station B's supplier now raises the wholesale price of its gasoline by
$0.10 per gallon, raising B's marginal cost to $3.10. Station A's supplier
keeps its price the same as before and refuses to sell to station B. Station
B can't find an alternative supplier. Station A hears a rumor about the potential
cost increase of its neighbor through a mutual friend at the Big Wheels Club.
If you owned Station A, and were thinking about the long-term consequences
or your actions, what would you do?