Calculate consumer surplus in the case of entry deterrence
Course:- Business Economics
Reference No.:- EM13141579

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Consider a homogeneous product industry with inverse market demand given by p = 1100 - 2Q There is currently one incumbent firm (firm 1) and one potential competitor (firm 2). Entry  into this industry implies a fixed cost of 450. Each firm has constant marginal cost of 300.

a) Calculate firm 1's profit-maximizing output and profits in the absence of potential competition.

b) Determine the Nash equilibrium in the case that firms 1 and 2 compete à la Cournot.

Now, suppose that firms 1 and 2 compete à la Stackelberg: Firm 1 decides on its production capacity first, followed by firm 2.

c) Calculate the output and profits of both firms in case firm 1 accommodates entry.

d) Does firm 1 enjoy a first-mover advantage, i.e., are its profits greater under Stackelberg competition than under Cournot competition?

e) Calculate the output firm 1 should set to deter entry.

f) Calculate consumer surplus in the case of entry deterrence and in the case of entry accommodation. Which situation leads to the largest consumer surplus?

g) In the case of entry accommodation, how far below 300 would firm 2's marginal cost have to fall so that it achieved the same market share as firm 1? In answering the question, assume that firm 1 knows this marginal cost when deciding on its own quantity. Furthermore assume that the marginal cost of the leader is still 300.

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