Question

Consider an industry comprised of a dominant firm with a competitive fringe. Each firm produces a homogenous good. Market demand is given by Q=a-bp. The dominant firm has a constant marginal cost c. There are three competitive fringe firms; each competitive fringe firm i faces a marginal cost of c+qi, where is qi is the output of firm i.

a.) What is the dominant firm’s residual demand curve?

b.) What is the output and profit level of each firm?

c.) Suppose the dominant firm merges with one of the competitive fringe firms. What is the output and profit level of the dominant firm after the merger? Do two firms have an incentive to merge?

Answer 1

There are 3 competitive fringe firms with each of them having identical marginal cost function

short run Supply curve is marginal cost curve of firm

Part a)

Part b) Dominant firm maximizes profit by producing at point where its marginal revenue equals marginal cost

marginal revenue for dominant firm is calculated using dominant firm’s residual demand curve

Part 3)

The dominant firm merges with one of the competitive fringe firms. Number of competitive fringe firms is 2

The merged would try to minimize its costs Therefore it will produce at minimum of marginal costs of the 2 firms

Dominant firm maximizes profit by producing at point where its marginal revenue equals marginal cost

marginal revenue for dominant firm is calculated using dominant firm’s residual demand curve

Profits of dominant firm increae post merger and output of fringe firms

Therefore merger is better for both competitive fringe as well as the dominant firm