Two firms compete in a homogeneous product market where the inverse demand funct

Question

Two firms compete in a homogeneous product market where the inverse demand function is P= 10-2 Q (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 year's rent of $0.5 million regardless of its production decision. Firm 1's marginal cost is $2, and Firm 2's marginal cost is $6. The current market price is $8 and was set optimally last year when Firm 1 was the only firm in the market. At present, each firm has a 50 percent share of the market. a. Based on the information above, what is the likely reason that Firm 1's marginal cost is lower than Firm 2's marginal cost? Limit pricing Second-mover advantage Learning curve effects Direct network externality b. Determine the current profits of the two firms. Instruction: Enter all responses rounded to two decimal places. Firm 1's profits:$ 2.30 million Firm 2's profits: S 0.30 million c. What would each firm's 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 profts: $7.30 million Firm 2's profits: S 30 million d. Suppose that, by cutting its price to $6, Firm 1 is able to dive Firm 2 completely out of the market. After Firm 2 exits the market, does Firm 1 have an incentive to raise its price? No es e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6? Yes No

Explanation / Answer

a) Learning curve effects

Explanation ....The concept that depicts the relation between cost and output over a defined period of time is learning curve effect.In this question the marginal cost their entry into the market as well as their current market price is vien which shows the learning curve effect.

b) Current profit of
Firm 1 = P = 10-2Q
i.e P = 10-2(2) marginal cost = 6 minus the costs involved = 6-0.5 = 5.5
and the current market price is 8, therefore the profit will be 8-5.5 = $2.5

Firm 2 = P=10-2Q
i.e, P = 10-2(6)marginal cost= -2 minus the costs involved = -2-0.5 =-2.05+and the current market price is 8, threfore the profit will be 8-(-2.05) = $10.5

c) Firm 1 - P-2Q = 10-2(2) = 6-.05 = 5.5 and the profit will be 6-5.5 = 0.5
Firm 2 profits will remain unchanged at 10.5

d) No

Expanation... both the firms have equal share in the market thus firm 2 also plays an improtant role in the market, so firm 1 cannot exit firm 2 from the market and have any incentive

e) No

Explanation... First of all predatory pricing is illegal so it is not possible. Also bothe the firms have equal share in the market and it cannot easily remove another one, so firm 1 cannot /is not engaging in any predatory pricing.

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