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# An incumbent sells steel and faces a potential entrant. Inverse demand curve for steel sales is given by by P = 400 – Q, where Q is the total amount…

• An incumbent sells steel and faces a potential entrant.

• Inverse demand curve for steel sales is given by by P = 400 – Q, where Q is the total amount sold by both firms.

• The marginal cost to transport one customer is MC = 100

• The entrant incurs fixed costs of F.

(a) What are the Cournot prices and quantities in the market, assuming the entrant enters?

(b) What are the Stackelberg prices and quantities in the market, if that the incumbent accommodates entry?

(c) Briefly explain why the profits for the incumbent are higher in (b) than (a).

(d) What happens if you take the Stackelberg quantity for the entrant and substitute it into the Cournot BRF for the incumbent? Does this exercise tell us anything about whether or not it is important that the incumbent commits to the Stackelberg quantity?

(e) Now suppose that the entrant incurs fixed costs to operate. Suppose the incumbent is thinking about using a “limit price” strategy, by committing to a quantity of 200. Calculate how large the fixed costs would have to be in order for the limit strategy to deter the entrant.

(f) Now suppose that the firms incur fixed costs to operate. As we discussed in class, if F = 0, limit pricing doesn’t make sense. What is the lowest level of fixed costs for the entrant, such that the incumbent would choose to accommodate entry?

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