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Firm 1 is the incumbent firm and has already incurred all fixed costs, which are sunk....

Firm 1 is the incumbent firm and has already incurred all fixed costs, which are sunk. Firm 2 is a potential entrant that must pay a sunk cost of 100 to enter the market. Assume that both marginal cost and average variable cost equal 0. Assume that the two firms produce differentiated products. Both firms have the following demand equation: qi = 30 – Pi + 0.5Pj if qj > 0. Pi is firm i’s price and Pj is firm j’s price. qi = 45 – 0.5Pi if qj equals 0. Assume that firm 1 can set a price that it will not be able to increase if the other firm enters. What is firm 1’s equilibrium price in this market? Explain how you derived this price.

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