Reference no: EM133083544
Two firms compete in a homogeneous product market where the inverse demand function is PQmultiple choice 1 = 10 -2 (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
- Direct network externality
- Learning curve effects
- Second-mover advantage
b. Determine the current profits of the two firms.
Instructions: Enter all responses rounded to 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?
Instructions: 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 or No
e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6?
Yes or No