Suppose there are only two firms that produce television sets, Sony and LG. Suppose Sony leads the market in television manufacturing and there main objective is to set prices in such a way that they maximize their profits. Because Sony leads, LG observes Sony’s behavior and responds with a certain level of output.
(a) What type of market is this? What is the main assumption of market price in this scenario and why do we need this assumption?
(b) Assume the following:
- Cost function of the leader (Sony) is c1(y1)=4y1 with marginal cost being Mc1=4.
- Cost function of the follower (LG) is c2(y2) =y22 with marginal cost being MC2 = 2y2/
What is the residual demand function? What is the optimality condition that the leader faces? What will the market price be? How much television sets will be outputted on the market?