Consider two firms competing to sell a homogeneous product by setting price.The inverse demand curve is given by P = 20 − Q.Firm 1 has MC₁(Q₁)= 2 and firm 2 has MC₂(Q₂)= 2.25.Based on this information,we can conclude that the market price will be: A) $2 and each firm will produce 9 units. B) $2.25 and each firm will produce 8.875 units. C) $2.24 and firm 1 will produce 17.76 units and firm 2 will produce 0 units. D) $2 and firm 1 will produce 18 units and firm 2 will produce 0 units.

Question

Quizplus · Accepted Answer

Given that both firms are competing in setting prices for a homogeneous product, the firm with the lower marginal cost (MC) can set a price just below the MC of the higher-cost competitor to capture the entire market. Firm 1, with an MC of $2, can set a price slightly below $2.25 (the MC of Firm 2) to capture the whole market. The inverse demand curve P = 20 - Q allows us to calculate the quantity Firm 1 will produce to maximize profit. Setting P equal to just below $2.25 would not make sense for Firm 1 since it can produce at $2 and still undercut Firm 2, thus capturing the market. However, the exact market price and quantities produced are determined by equating MC to MR (marginal revenue), which is derived from the demand curve. Without further calculations, the scenario suggests Firm 1 undercuts Firm 2, capturing the market, but the specific quantities and price provided in option C are not directly derivable from the given information without additional calculations. Therefore, the explanation focuses on the strategic undercutting aspect rather than the specific figures.

Consider Two Firms Competing to Sell a Homogeneous Product by Setting