Two firms compete in a homogeneous product market

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Reference no: EM131169427

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? Second-mover advantage Limit pricing Learning curve effects Direct network externality 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? Yes No e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6? (Click to select)NoYes

Reference no: EM131169427

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