•Exercise #4. Consider a market with an incumbent, firm 1, facing the entry of a rival, firm 2. Firm 1 can make an inves

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•Exercise #4. Consider a market with an incumbent, firm 1, facing the entry of a rival, firm 2. Firm 1 can make an investment, 𝐾1, to accommodate or deter the entry of firm 2. The inverse demand in this market is 𝑝(𝑄)=16−𝑄 where 𝑄=𝑞1+𝑞2. Firms produce a homogeneous good and are Cournot competitors. Firm 1’s cost function is 𝑐1(𝑞1,𝐾1)=(4−𝐾1)𝑞1+𝐾1^2/2 and firm 2’s cost is 𝑐2𝑞2=4𝑞2.
•Start with the second-stage decisions.
•Q13) Determine firm 1’s best-response functions 𝑞1(𝑞2,𝐾1)
•Q14) Determine firm 2’s best-response functions 𝑞2(𝑞1)
•Q15) Assuming firms 1 and 2’s best-response functions are drawn on a graph with 𝑞2 on the horizontal axis and 𝑞1 on the vertical axis, determine the effects of an increase in firm 1’s investment 𝐾1 on the firms’ best-response functions.
–A) Firm 1’s best-response function shifts up and firm 2’s best-response function shifts up
–B) Firm 1’s best-response function shifts up and firm 2’s best-response function shifts down
–C) Firm 1’s best-response function shifts up and firm 2’s best-response function does not move
–D) Firm 1’s best-response function shifts down and firm 2’s best-response function shifts up
–E) Firm 1’s best-response function shifts down and firm 2’s best-response function shifts down
–F) Firm 1’s best-response function shifts down and firm 2’s best-response function does not move
–G) Firm 1’s best-response function does not move and firm 2’s best-response function shifts up
–H) Firm 1’s best-response function does not move and firm 2’s best-response function shifts down
–I) Firm 1’s best-response function does not move and firm 2’s best-response function does not move
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