Let the widget industry demand curve be given by P= 200 - Q, where Q is the industry output. There are two firms, Firm 1 and Firm 2. Each has a marginal cost of $20.

1. Assume that these two firms compete as in the Cournot model. Calculate each firm's profit in the Cournot equilibrium. (4 points)

2. Firm 1 discovers a technique that will allow it to credibly pre-commit to any given level of output that it wants. To install this technology costs $1,200. Once installed, production costs are simply $20 times the level of output to which Firm 1 has pre-committed. Firm 1 can make a one-time choice of the level of output to which it will pre-commit itself. Firm 2 does not have this technology, and must simply respond to whatever output that Firm 1 chooses to pre-commit to. Firm 1 faces two courses of action. First, it can decide to pass on the investment, and, instead, stick with its Cournot profit; it doesn't have to invest in the new technology. Second, Firm 1 can decide to make the $1,200 investment in the alternative technology that, essentially, allows it to pre-commit to a specific output of Firm 1's choice, thereby creating complete inflexibility once it has done so. Which of these two courses of action should Firm 1 take? Be specific and numerical in your answer.

Please focus on question 2

Answer rating: 100% (QA)

To determine which course of action Firm 1 should take in question 2 we need to compare the profits under each scenario sticking with the Cournot profit or making the 1200 investment to precommit to a ... View the full answer