Two Donut producers that set prices and sell differentiated products propose to merge. Firm A sells Bearclaws for a price of $10 with a marginal cost of $5. Firm B sells Crullers for a price of $12 and a marginal cost of $6.

a. When the price of Bearclaws rises, 10% of its lost demand goes to Crullers. What is the marginal cost reduction for Bearclaws rises that is required to offset the upwards pricing pressure on the Bearclaws price?

b. You are employed as a consultant by the merging firms. You know that the DOJ knows that the marginal cost of Crullers will fall by 60 cents as a result of the merger, but that the agency is unsure of the diversion ratio between Crullers and Bearclaws. How small will you need to claim that the diversion is in order for there to be no net upwards pricing pressure on the Bearclaws price?