Question
Firm A and Firm B are selling differentiated products and compete in Bertrandmanner. Initially the CEOs' compensations in both companies were tied to the company's
Firm A and Firm B are selling differentiated products and compete in Bertrandmanner. Initially the CEOs' compensations in both companies were tied to the company's profit so each CEO'sobjective is to set price to maximize his/her firm's profit. [For simplicity, assume that the CEOs' efforts have no effect on the firms' profits.] Let the firm A's profit be denoted byA firm B's profit byB. Because the firms are symmetric, in the original equilibrium they earn the same profit and each firm has 50% market share. Suppose Firm S is Firm A and Firm B's supplier. SupposeFirmA'sboardofdirectorsdecidedtouseFirmB'sprofitasthebenchmarktomeasureitsownCEO'sperform. More specifically, Firm A's CEO'scompensation is tied to (A - B) (and this was known to Firm B). Please explainhowFirmA'schangeincompensationschemeforitsCEOaffectedthecompanies'prices.Inthenewequilibrium, which firm charged a higher price?
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