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 $1.6 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 sh
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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 $1.6 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.
Determine the current profits of the two firms.
Firm 1's profits: $
Firm 2's profits: $
What would each firm’s current profits be if Firm 1 reduced its price to $10 while Firm 2 continued to charge $15?
Firm 1's profits: $
Firm 2's profits: $
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?
YES
NO
Is Firm 1 engaging in predatory pricing when it cuts its price from $15 to $10?
YES
NO
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