Question

Firm A sells a good and faces an inverse demand curve of P = 120 – Q, has constant marginal costs of 60 and no fixed costs

(c) For each of the following four situations: (1) state whether you would expect quantities Qa and Qb to rise, stay the same or fall, and (2) provide a brief (two to three sentence maximum) explanation. Note: I’m not looking for nor expecting *any* calculation here. A brief explanation of how and why Qa and Qb might change is perfectly sufficient.

(c1) Qa and Qb both have to pay fixed costs F>0. Both firms choose to compete in the market and choose quantities simultaneously, just like in part (b).

(c2) Fixed costs are zero, but A is an incumbent who can commit to a quantity before B enters.

(c3) The two firms compete as in part (b), but do so repeatedly, rather than just once.

(c4) The firms compete a single time, but compete by setting the price of the identical product rather than the quantity.

Answer 1

Given data:

Firm A sells a good and faces an inverse demand curve of P = 120 – Q

has constant marginal costs = 60

(c) For each of the following four situations:

(c1) Qa and Qb both have to pay fixed costs F>0:

We must note that introducing the fixed cost will not change the quantity produced by the firm and it will remain same.

This is because in profit max condition we consider marginal cost and not total cost which is still same.

Although quantities and process remain same, profits will fall for both firms.

(c2) Fixed costs are zero, but A is an incumbent who can commit to a quantity before B enters:

A commits to a pre-decided quantity. So in this quantity is decided by A. So he sets a larger quantity.

So we say Q_A will rest and Q_B will decline. This is because as A is an incumbent and sets quantity he/she enjoys first move advantage. So Q_{A >} Q_B and also π_A > π_B.

(c3) The two firms compete but do so repeatedly, rather than just once:

In real life if repeated game quantity competition is observed from output can increase/decrease/stay constant as each firm has an incentive to deviate from its exist policy.

(c4) The firms compete a single time, but compete by setting the price of the identical product rather than the quantity:

If the firms now compete on the basis of price then the firm setting lower price gets the entire market demand.

Moreover the one who is setting price will enjoy second move advantage . So if firm B sets a lower than A then B will get entire demand and

                                                Q_{B   >} Q_A