Two firms compete by setting prices of identical products Co

Two firms compete by setting prices of identical products. Consumer purchase from whichever firm offers the lowest price.

a) If both firms have identical marginal costs, briefly explain why the Nash equilibrium is where both firms set price equal to marginal cost.

Solution

a) Firms will set price at MC to avoid these two situations:

First, Firms don’t want to set a price that is so low that it would result in negative profits if they managed to attract consumers at this price. Since they are assuming no recurring fixed costs and constant same marginal costs, this means they don’t want to set a price below marginal cost. Second, a firm similarly won’t set a price below marginal cost and also doesn’t want to set a price higher than MC because then the firm will not get any customers. Hence price equals to MC would be the nash equilibrium.

b) In case different MC, price would be set at higher MC. that is $60.