Two firms compete in a homogeneous product market where the inverse demand function isP= 10 -2Q(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 $0.7 million regardless of its production decision. Firm 1's marginal cost is $2, and Firm 2's marginal cost is $6. The current market price is $8 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?

• Learning curve effects

b. Determine the current profits of the two firms.

Instruction: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 $6 while Firm 2 continued to charge $8?

Instruction:Enter all responses to two decimal places.

Firm 1's profits: $million

Firm 2's profits: $million