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Captain Morgan’s spiced rum and Connor McGregor’s Irish whiskey, “Notorious”, can be considered differentiated products because some consumers prefer one over the other and do not all decide to buy the cheaper liquor. Let the demand for bottles of Captain Morgan’s be qM = 4 − pM + δpN and the demand for bottles of Notorious be qN = 4 − pN + δpM where pM and pN are the prices of the two liquors, respectively. For simplicity, assume the liquors are costless to produce.
(a) What determines whether the products are substitutes or complements? Why?
(b) Suppose δ = 0.75 and that the owners of each liquor compete in Bertrand competition. Draw the best response functions.
(c) Suppose the owners of Captain Morgan’s purchase Notorious. Write out the new “best response functions” corresponding to the pricing problem faced by the owners of Captain Morgan’s. On the same diagram drawn in (b), plot them. Show on your diagram how prices changed after the merger.
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