Two firms compete in a homogeneous product market where the inverse demand funct
ID: 1214142 • Letter: T
Question
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 year’s rent of $0.35 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?
b. Determine the current profits of the two firms.
Instruction: Round all answers to the nearest penny (two decimal places).
Firm 1's profits: $ million
Firm 2's profits: $ 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: Round all answers to the nearest penny (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?
e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6?
(Click to select)NoYes
Explanation / Answer
a.
Firm 1 produced last year = P = 10 – 2Q = 8
Q = 2/2 = 1 million
Profit maximizing price MR = MC
10 – 4Q = MC
Firm’s first marginal cost = firm’s second marginal cost = $6
Hence, firm’s 1 MC has decreased over time due to learning curve effects.
b.
Current market price = $8
Total market output = 1 million
Fixed cost of each firm = $1 million
Sell of each firms is 0.5 million units.
Firm’s 1st profit = ( $8-$2) * 0.5 - $1 = $2 million
Firm’s second profit = ($8-$6) * 0.5 - $1 = 0
c.
firms first profit will increase = ($6-$2) *2 - $1 = $7 million
firms second profit would decrease to -$1 million
firm first P = 10 -2Q
6 = 1- - 2Q
2Q = 10 – 6
Q = 2 million
Firm first has released 2 million quantities to market while total demand is 1 million. Therefore demand for second firm will drop = ($8-$6) *0 - $1 = -$1 million
d.
No, $6 is monopoly price.
e.
No, it is not pricing below its own MC.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.