Question: We analyze the market for taxi services is a small city. The market demand for taxi is \(Q^{d}(p)=40-2 p\) and consumers value the service provided by different companies equally (homogeneous product)

Suppose the government regulates the taxi market and allows only two firms to operate in the market. Both firms decide how many cabs to buy and to operate in the city. Both firms have identical marginal costs \(mc=2\) of purchasing and operating one cab and pay no fixed costs.

1. Find two best response function of each firm and calculate a Cournot equilibrium. Illustrate your answer with a diagram.
2. Would it pay for Firm1 and Firm 2 to form a cartel? How much each firm gain/lose if they choose to form a cartel?
3. What will be the gain to the society if Firm 2 enter the taxi market monopolized by Firm 1? What is the welfare loss of a duopoly market relative to perfect competition?

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