Two firms compete in a homogeneous product market where the inverse demand function is P = 10 -2Q (quantity is measured in millions). Firm 1 has been in business for one year, while Firm 2 just recently entered the market. Each firm has a legal obligation to pay one yearâs rent of $0.7 million regardless of its production decision. Firm 1âs marginal cost is $2, and Firm 2âs marginal cost is $6. The current market price is $8 and was set optimally last year when Firm 1 was the only firm in the market. At present, each firm has a 50 percent share of the market.
a. Based on the information above, what is the likely reason that Firm 1âs marginal cost is lower than Firm 2âs marginal cost?
Limit pricing
Direct network externality
Second-mover advantage
Learning curve effects
b. Determine the current profits of the two firms.
Instruction: Enter all responses rounded to two decimal places.
Firm 1's profits: $ ______ million
Firm 2's profits: $ _______ million
c. What would each firmâs current profits be if Firm 1 reduced its price to $6 while Firm 2 continued to charge $8?
Instruction: Enter all responses to two decimal places.
Firm 1's profits: $ ______ million
Firm 2's profits: $ ______ million
d. Suppose that, by cutting its price to $6, Firm 1 is able to drive Firm 2 completely out of the market. After Firm 2 exits the market, does Firm 1 have an incentive to raise its price?
Yes
No
e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6
Yes
No
Two firms compete in a homogeneous product market where the inverse demand function is P = 10 -2Q (quantity is measured in millions). Firm 1 has been in business for one year, while Firm 2 just recently entered the market. Each firm has a legal obligation to pay one yearâs rent of $0.7 million regardless of its production decision. Firm 1âs marginal cost is $2, and Firm 2âs marginal cost is $6. The current market price is $8 and was set optimally last year when Firm 1 was the only firm in the market. At present, each firm has a 50 percent share of the market.
a. Based on the information above, what is the likely reason that Firm 1âs marginal cost is lower than Firm 2âs marginal cost?
Limit pricing
Direct network externality
Second-mover advantage
Learning curve effects
b. Determine the current profits of the two firms.
Instruction: Enter all responses rounded to two decimal places.
Firm 1's profits: $ ______ million
Firm 2's profits: $ _______ million
c. What would each firmâs current profits be if Firm 1 reduced its price to $6 while Firm 2 continued to charge $8?
Instruction: Enter all responses to two decimal places.
Firm 1's profits: $ ______ million
Firm 2's profits: $ ______ million
d. Suppose that, by cutting its price to $6, Firm 1 is able to drive Firm 2 completely out of the market. After Firm 2 exits the market, does Firm 1 have an incentive to raise its price?
Yes
No
e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6
Yes
No
