Question

Problem 3 Suppose two firms are strategically and independently deciding what price to set for their new brand of soda. Firm 1 (Super Soda) and Firm 2 (Fizzy Soda) are competing on price. There are 1 million consumers who are willing to pay up to $3 per bottle of Super Soda, and they are willing to pay up to $3 per bottle of Fizzy Soda. However, consumers will all purchase Super Soda if Super Soda chooses a price lower than the price of Fizzy Soda and consumers will all purchase Fizzy Soda if Fizzy Soda chooses a price lower than that of Super Soda. If both firms charge the same prize, they split the market evenly. Each firm has a marginal cost of $1 per bottle of soda.

A) If each firm chooses a price to maximize its profits, anticipating what the other firm will do, what price should each firm charge?

B) At the prices in part A), what profit will each firm make?

Answer 1

A).

Consider the given problem here there are two firms “firm1” producing “super soda” and “firm2” producing “fizzy soda” with price “Ps” and “Pf” respectively. Now, their marginal cost of producing each types of soda are same “$1”, => “MC=$1”. Now, all the consumers want to pay maximum of “$3” for both types of soda and both of the firms want to maximize their own profit, => both of them will charge less than “$3” and one of the firm want to charge lower price compare to other in order to capture the whole market. So, both the firms engaged in same price war. Finally both of they end up with “Ps=Pf=$1”. They can’t charge less than “$1” because if they does so they have to incur losses. So, here they will charge “Ps=Pf=MC=$1”.

B).

SO, here at the equilibrium “P=MC”, => both the firms are getting normal profit, => zero economic profit.