Suppose market demand is p = 10 - Q. Firms incur no cost of production. If firm A is the incumbent, can it deter the entry of its rival, firm B?
What will be an ideal response?
Firm B's reaction function is qB = 5 - (1/2 )qA. Knowing this, firm A's profit function is ? = 5qA - q2A/2. The Stackelberg leader maximizes profit at a quantity of 5 and firm B will produce 2.5. Firm A's profit is 12.5. If firm A produces more, firm B will still enter and earn a profit. Firm B must earn a profit since it faces no costs. Firm A's profit falls as its output increases. So firm A cannot deter entry and is better off accommodating firm B.
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