Firms in some industries with a small number of competitors earn normal economic profit. The Wall Street Journal (Gomes, Lee, “Competition Lives On in Just One PC Sector,” March 17, 2003, B1) reports that the computer graphics chips industry is one such market. Two chip manufacturers, nVidia and ATI, “both face the prospect of razor-thin profits, largely on account of the other’s existence.”

a. Consider the Bertrand model in which each firm has a positive fixed and sunk cost and zero marginal cost. What are the Nash equilibrium prices? What are the Nash equilibrium profits?

b. Does this “razor-thin” profit result imply that the two manufacturers necessarily produce chips that are nearly perfect substitutes? Explain.

c. Assume that nVidia and ATI produce differentiated products and are Bertrand competitors. The demand for nVidia’s chip is q_V = a - bρ_V + cρ_A; the demand for ATI’s chip is q_A = a - bρ_A + cρ_V, where r_V is nVidia’s price, ρ_A is ATI’s price, and a, b, and c are coefficients of the demand function. Suppose each manufacturer’s marginal cost is a constant, m. What are the values of a, b, and c for which the equilibrium profit of each chip manufacturer is zero? In answering this question, show that despite differentiated products, duopoly firms may earn zero economic profit?