Suppose that an incumbent dominant firm produces with a cost function given by C = 100 + 1 . 5 q 2 i so that marginal cost is given by MC = 3 q i . Inverse demand is P = 200 − Q where Q is total output of all sellers. Suppose that a second firm is in the market with a cost function C = 100 + 110 q e . If the incumbent sets a price equal to 74 and meets all of the market demand at that price, is this price “predatory” under the Areeda-Turner “marginal cost” test? Is the same price “predatory” under the Areeda-Turner average variable cost ( AVC ) test? If the “victim” firm can ensure itself half of the market, but the dominant firm remains the price leader, is there a price that the incumbent firm can set that will drive out the rival firm but not violate the Areeda-Turner AVC test? Which firm is more “efficient”? Criticize the Areeda-Turner test on the basis of these exercises.
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