Consider a Bertrand model with two firms facing the market demand Q(p)= 100 - p . Both firms have a constant marginal cost of 20. The firms compete over prices, but each firm has a production capacity of 25 units.
a) If Firm 1 believes that Firm 2 will use up all of its capacity, what price does it charge? In a diagram, show Firm 1’s residual demand and the profit-maximizing price.
b) What do you expect the Nash equilibrium to be for this capacity constraint Bertrand competition? Explain your answer.