The inverse market demand for a homogenous product is given by P=1000-Q, where Q is the industry output and P the market price of the product in the market. There are two firms with asymmetric costs that produce the product in the market. Firm 1 has a per unit production cost equal to 20 (i.e., c1= 20) and Firm 2 has a per unit production cost equal to 30 (i.e., c2=30).

 

a) Assume the firms compete in quantities (i.e., q1 and q2) and make their choices sequentially (i.e., Stackelberg). Consider both cases, i.e., when Firm 1 is the leader and when Firm 2 is the leader. What are the firms' profits in equilibrium?

b) Suppose that Firm 2 has now discovered a cost-reducing technology which allows production with a per unit cost of 15 (i.e., c2=15). What are the firms' profits in equilibrium now? Compare and discuss your findings.

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SOLUTION a We can solve for the equilibrium quantities and prices using the Stackelberg model If Firm 1 is the leader Firm 1 chooses its quantity q1 to maximize its profit taking into account the fact ... View the full answer