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econ105_10s_ps7

# econ105_10s_ps7 - Problem Set 7(Due date Nov 19th ECON105...

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Problem Set 7 (Due date: Nov 19 th ) ECON105 Industrial Organization and Firm Strategy Professor Michael Noel University of California San Diego 1. Assume an incumbent who can choose advertising level K in the first period. In the second period, the entrant may enter by paying a fixed cost F. If it enters, the two firms play Cournot, otherwise the incumbent is a monopoly. Demand is given by P = K q 1 q 2 . There are no marginal costs. The cost to the incumbent of K units of advertising is C(K) = K 3 . (Don’t forget to include this at the end of the incumbent’s profit function you write down.) a. What K does the incumbent choose if entry is blockaded? For what F is entry blockaded? b. What K does the incumbent choose if it wishes to deter entry? What are its profits (as a function of F) when it deters entry? c. Does investing in K make the incumbent soft or tough? Does the incumbent over or underinvest in K when deterring? d. What K does the incumbent choose if it accommodates entry? What are its profits if it accommodates entry? e. For which F will the incumbent deter? For which F will the incumbent accommodate? f. Does the incumbent over or underinvest when accommodating? To find out, calculate K OL , the K that it would choose if the entrant were unable to observe and react to the incumbents choice of K. Then your answers to parts d. and e. g. Let us try to answer e. another way. Calculate the strategic effect of K on the incumbent’s profits. Is it positive or negative? Should the incumbent over or underinvest? h. Verify that the total derivative of K on the incumbent’s profits is equal to the direct effect of K on the incumbent s profits plus the strategic effect of K on firm 1’s profits via q 2 . i. Let us try to answer e. yet a third way. Can you use the taxonomy approach (ie. think furry animals) to decide whether or not the incumbent should over or underinvest? If not, why not? If so, which strategy does this game call for and does it call for over or underinvestment? 2. A new firm (the "entrant", firm 2) is about to enter an industry currently dominated by a monopolist (the "incumbent", firm 1.) The entrant does not have to pay a start up fee so entry cannot be deterred. When the entrant enters in the second period, the two firms will produce differentiated products and compete in prices (chosen simultaneously.) MC = 0 for both

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