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Two firms compete in a homogeneous product market where the inverse demand function is P = 10 2Q (quantity is measured in millions). Firm 1 has been in business for one year, while Firm 2 just recently entered the market. Each firm has a legal obligation to pay one years rent of $0.25 million regardless of its production decision. Firm 1s marginal cost is $2, and Firm 2s marginal cost is $6. The current market price is $8 and was set optimally last year when Firm 1 was the only firm in the market. At present, each firm has a 50 percent share of the market. a. Based on the information above, what is the likely reason that Firm 1s marginal cost is lower than Firm 2s marginal cost?

multiple choice 1

Second-mover advantage

Learning curve effects

Direct network externality

Limit pricing

b. Determine the current profits of the two firms. Instructions: Enter all responses rounded to two decimal places. Firm 1's profits: $ million

Firm 2's profits: $ million c. What would each firms current profits be if Firm 1 reduced its price to $6 while Firm 2 continued to charge $8? Instructions: Enter all responses to two decimal places. Firm 1's profits: $ million

Firm 2's profits: $ million d. Suppose that, by cutting its price to $6, Firm 1 is able to drive Firm 2 completely out of the market. After Firm 2 exits the market, does Firm 1 have an incentive to raise its price?

multiple choice 2

No

Yes

e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6? multiple choice 3

Yes

No

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