Question

Consider the market for DVD players and HDTVs (high-definition televisions). A firm can produce DVD players at an average cost of $20 each, or HDTVs at a cost of $150 each. Which product should this firm produce if the price of DVD players is $15 and the price of HDTVs is $200? Why? Explain what you would expect other firms in both the markets for DVD players and HDTVs to do. Assume both markets are competitive.

Answer 1

I would prefer the firm to produce HDTVs as there are profits associated with this transaction. An average profit of $50 (200-150=$50) is being made while selling HDTVs. On the other hand, the firms incur loss of $5 (15-20=-$5) while they sell DVDs. Hence a wiser option would be to avoid these losses and sell HDTVs only.

As far as the other firms are concerned in the DVDs market, they can maximize their profits by setting up optimal prices by solving when marginal revenue equals marginal cost. Since our firm is not interested in producing DVDs, this is the most viable option for other firms. In the market of HDTVs, the firms essentially try to set the market at equilibrium as it's a competitive market. So, they set the price equal to their marginal cost, which is equal to $200 in which our firm sells. Therefore the firms react in order to bring back the market equilibrium.

Hope this helps. Cheers!