Solved: Financing a Strategic Investment under Quantity

Competition Suppose you own

Financing a Strategic Investment under Quantity Competition Suppose you own

Financing a Strategic Investment under Quantity Competition: Suppose you own a firm that has
invented a patented product that grants you monopoly power. Patents only last for a fixed
period of time — as does the monopoly power associated with the patent. Suppose you are
nearing the end of your patent and you have the choice of investing in research that will result in
a patented technology that reduces the marginal cost of producing your product.

A: The demand for your product is linear and downward sloping and your current constant
marginal cost is MC. There is one potential competitor who faces the same constant MC.
Neither of you currently face any fixed costs, and the competitor observes your output before he
decides whether and how much to produce.

(a) If this is the state of things when the patent runs out, will you change your output level?
What happens to your profit?

(b) Suppose you can develop an improved production process that lowers your marginal cost to
MC? (c) If MC? is relatively close to MC, will you be able to keep your competitor out? In this
case, might it still be worth it to invest in the technology?

(d) If the technology reduces marginal costs by a lot, might it be that you can keep your
competitor from producing? If so, what will happen to output price?

(e) Do you think that investments like this—intended to deter production by a competitor—are
efficiency enhancing?

(f) Suppose the potential competitor could also invest in this technology. Might there be
circumstances under which your firm will invest and your competitor does not?

B: Suppose again that demand is given by x = A ??p, that there are currently no fixed costs, that
all firms face a constant marginal cost c and that you are about to face a competitor (because
your patent on the good you produce is running out).

(a)What will happen to your output level if you simply engage in the competition by producing
first. What will happen to your profit?

(b) If you lower your marginal cost to c? (c) Suppose that A = 1000, c = 40 and ? = 10. What is
the highest FC can be for you to decide to go ahead with the investment if the new marginal
cost is c? (d) Now consider the competitor. Suppose he sees that firm1 has invested in the
technology (and thus lowered its marginal cost to c?.) Firm 2 finds out that the patent on firm
1’s technology has been revoked—making it possible for firm 2 to also adopt the technology at a

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 recurring fixed cost FC. What is the highest FC at which firm 2 will adopt the technology?
Denote this FC2.

(e) Suppose c? = 20. For what range of FC will firm1 adopt and firm 2 not adopt the technology
even if it is permitted to do so?

Financing a Strategic Investment under Quantity Competition Suppose you own

ANSWER
https://solvedquest.com/financing-a-strategic-investment-under-quantity-competition-suppose-
you-own/

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