Problem 2. [Dixit model and Entry Deterrence] Consider the Dixit model of capacity expansion and entry deterrence, where Incumbent company in the market for streaming service (Notflix) chooses capacity K1 in the first stage. Potential entrant (Jeff Prime) in period 2 observes incumbent's capacity choice. If entry takes place, firms play a Cournot game in the second period. Marginal cost of production is c=2 for both Incumbent and Entrant. The unit cost of installing additional capacity in the second stage is c0=8. Fixed costs of entry are given by F=73. Inverse demand is given by P=40q1q2. (a) (1 point) Suppose entry is accommodated, derive the second-stage best-response functions for both Incumbent and Entrant. Draw the best response functions in the (q1,q2)-diagram. Explain the shape of these functions. (b) (1 point) Compute the level of K1 (capacity investment) by Incumbent in the first stage that will allow to deter entry in the second stage. Draw the new best-response diagram that corresponds to the entry deterrence situation. Problem 2. [Dixit model and Entry Deterrence] Consider the Dixit model of capacity expansion and entry deterrence, where Incumbent company in the market for streaming service (Notflix) chooses capacity K1 in the first stage. Potential entrant (Jeff Prime) in period 2 observes incumbent's capacity choice. If entry takes place, firms play a Cournot game in the second period. Marginal cost of production is c=2 for both Incumbent and Entrant. The unit cost of installing additional capacity in the second stage is c0=8. Fixed costs of entry are given by F=73. Inverse demand is given by P=40q1q2. (a) (1 point) Suppose entry is accommodated, derive the second-stage best-response functions for both Incumbent and Entrant. Draw the best response functions in the (q1,q2)-diagram. Explain the shape of these functions. (b) (1 point) Compute the level of K1 (capacity investment) by Incumbent in the first stage that will allow to deter entry in the second stage. Draw the new best-response diagram that corresponds to the entry deterrence situation