Assume that two firms operate in a market which has a demand function Q = 12 - 1

Question

Assume that two firms operate in a market which has a demand function Q = 12 - 1P. Firm 1's output is designated by q1 and firm's 2's output is designated by q2. Because there are only two firms, the output on the market Q is equal to the sum of the two firms' outputs q1 and q2 respectively. It is important to note that, in this market, each of the two firms has a substantial impact on the market price. It is not like the model of pure competition where there are a sufficiently large number of firms that each firm has such a negligible impact on price that it takes the market price as given.
Assume that each firm is producing 4 units of output. If each firm assumes that the other firm will continue producing 4 units, will either of them have an incentive to change the output level given that each firm is attempting to maximize their total revenue.

Select one:

a. Neither firm will have an incentive to change their output

b. Firm one has an incentive to expand its output

c. Firm two has an incentive to expand its output

d. Each firm has an incentive to expand its output

Explanation / Answer

A is Correct as the two firms increase there output price will fall which lowers the profitability

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