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Is the threat credible

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Reference no: EM13190036

The widget industry is currently a monopoly facing the demand curve P=200-20Q, where Q is total industry output. Firm 1 is the monopolist and has a marginal cost of $20. Firm 2 is a potential entrant and must pay $130 up front to enter. Once it pays the $130, its only cost is its marginal cost, which is also $20.

Firm 1 would like to deter Firm 2 from entering. If Firm 2 does enter, each firm will choose an output level qi (i=1,2), and will be rewarded according to the following formula:

Profit(i)=qi[200-20(q1+q2)-20]

a. Firm 1 tries to deter Firm 2 from entering by announcing publicly that if entry occurs, (by Firm 2), then q1=4 units of output. Is this threat credible?

b. Suppose Firm 1 announced instead that if Firm 2 enters that q1=3. Is this threat credible?

c. If either of these two alternative threats is credible, does it deter entry by Firm 2?

Reference no: EM13190036

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