Suppose that the inverse demand function is described by: P = 1002(q1+q2), where

q1 is the output of the incumbent firm and q2 is the output of the entrant. Let the

labor cost per unit w = 20 and capital cost per unit be r = 20. In addition, let each

firm have a fixed cost of F1 = F2 = $100.

(a) (4 pts) Suppose that in stage one the incumbent invests in capacity K1. Show

that in stage two the incumbent's best response function is q1 = 20 q2/2 when

q1 K1; and q1 = 15 q2/2 when q1 > K1.