Consider an industry with inverse demand: p (y) = 90 − y where y denotes industry output. There are two firms: firm 1 is the incumbent firm and firm 2 is the potential entrant. Firm 1 can adopt one of two technologies.
Technology A is labor intensive and is characterized by a cost function: CA (y) = 200 + 30y
Technology B is capital intensive, producing goods at zero marginal cost but at a very high fixed cost CB = 1600.
After firm 1 has chosen its technology, firm 2 can consider entering.
However, it has only one technology choice, the labor-intensive, technology A. If it enters, the two firms compete in quantities.
Questions:
b) Suppose firm 1 adopts technology A. Derive the best replies of the two firms in the post-entry game and show that firm 2 will enter.
c) Determine the subgame perfect equilibrium.