Reference no: EM131774887

Question: Consider a firm (Firm X) with some monopoly power that is producing a good that may have positive network effects if a critical mass of consumers can be attracted to the product during Period 1. Suppose that selling 50 units of the product during Period 1 would be sufficient to get a "bandwagon effect" going. However, what if selling 50 units would require a low, introductory price that would reduce profits during Period 1? If a bandwagon effect did occur, would there be enough extra profits in Period 2 to compensate for the loss of profits in Period 1? (Assume that, after 2 periods, another market craze will strike consumers, and the demand for Firm Xs product will become zero. Firm X anticipates that this will happen.) Suppose that there is a constant marginal (and average) production cost of $5 per unit. The demand curve for Period 1 is given by: P = 75 - Q. Unless a bandwagon effect occurs, the same demand curve will exist in Period 2. However, if a bandwagon effect occurs, the demand curve in Period 2 will become P = 75 - Q/1.2. What should Firm X do? Determine the marginal revenue (MR) curve for Period 1. Set MR = MC and solve for the profit-maximizing values for Q and P. Determine the amount of profit. Show your work. If Q = 50 for Period 1, what would happen to the price the firm has to charge (in Period 1)? What then would be the profit for Period 1? What would subsequently happen to profits in Period 2? Show your work.

So what should Firm X do? Is the market rate of interest (assuming that it is a positive number) relevant for answering the questions here? Explain.