Two large test providers dominate the market for Covid tests in Spreadfield: Firm 1 and Firm 2. Their total monthly costs are given by TC1 = 15,000+10q1 and TC2 = 18,000+20q2, where q1 is the output of firm 1, and q2 is the output of firm 2.

The demand curve for Covid tests in Spreadfield is as follows:

P = 600 - 2Q

where Q = q1 + q2.

Each firm decides how many test kits to produce, taking as given the output decision of the other firm.

A. (1 point) Which type of competition do the two firms engage in?

B. (5 points) Compute the reaction function for each firm. [Hint: careful - are marginal costs the same?]

C. (6 points) Find the equilibrium quantities and the price of Covid tests in Spreadfield.Calculate the monthly profit of each firm in equilibrium.

An unidentifiable problem raises the marginal costs in firm 1 to 40. Assume that this problem persists throughout the remaining exercises (as long as firm 1 operates).

D. (6 points) Write down the new cost function of firm 1, the new reaction function, and the equilibrium price and quantities of Covid tests in Spreadfield. Write down the profits of each firm.

E. (2 points) Will firm 1 continue to produce in the long run, despite the increased marginal costs?

F. (3 points) The owner of firm 1 read in the WSJ that firms can compete on prices, and decides to pursue this strategy. Assume that firm 2 also responds by changing its price. How is this competition called, and what is the most likely short-run outcome (market price and total quantity produced)? [assume there's no collusion]

As a result of the fierce competition under F., firm 1 exits the market forever, posing no threat of re-entry. Firm 2 is now the sole producer.

G. (2 points) What is the optimal price that firm 2 should charge? What is the corresponding quantity of Covid tests? What are firm 2's profits?

H. (3 points) Suppose the government takes control of firm 2 in Spreadfield. The government is now producing the Covid tests there and is selling them at marginal cost (i.e., firm 2's marginal cost). What is the increase in consumer surplus (compared to the situation in G.)? Does this outweigh the cost to the government (who have to take over the full cost of production)?