Problem M2-03 (algo)

Two firms compete in a homogeneous product market where the inverse demand function is P = 20 5Q (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 $1 million regardless of its production decision. Firm 1's marginal cost is $2, and Firm 2's marginal cost is $10. The current market price is $15 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?

multiple choice 1

• Learning curve effects
• Limit pricing
• Second-mover advantage
• Direct network externality

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 $10 while Firm 2 continued to charge $15? 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 $10, 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?

multiple choice 2

• Yes
• No

e. Is Firm 1 engaging in predatory pricing when it cuts its price from $15 to $10? multiple choice 3

• Yes
• No