Question

ms (Natural Salt and Healthy Salt) compete in the market for Himalayan table salt onsumers see the salt produced by both firms as perfect substitutes. In this market, each firm chooses what output to produce and price is determined by aggregate output. Market demand is given by 450-2P, where Q is kgs and P is E/kg. The initial marginal cost of Natural Salt is 5o g. The respective for Healthy Salt is 40/kg. A process innovation in the production technology of Himalayan table salt would reduce the Natural Salt's marginal cost to 44 and Healthy Salt's marginal cost to 34 (a) Consider that only one of the two firms can introduce the aforementioned process innovation in its production technology, while its rival firm still produces with its initial marginal cost. How much would each firm be willing to pay so as to introduce the aforementioned process innovation in its production te chnology? [Mark 1.0] (b) Consider that each firm has the option to pay 1,000 euros so as to introduce the aforementioned process innovation in its production technology. Given each firm's decision, on whether to introduce the innovation or not, firms compete in the market by choosing simultaneously their level of output. If you were the Natural Salt's manager would you suggest the introduction of the innovation or not? What would you suggest if you were the Healthy Salt's manager? [Hint: Construct a payoff matrix.J IMark 1.5 (c) Assume that Natural Salt and Healthy Salt decide on the following: Healthy Salt pays 1,000 euros and introduces the process innovation. Then, the two firms merge and produce with marginal cost equal to 34. Healthy Salt keeps 500 euros of the post-merger firm's profits (half of the process innovation's cost) and the remaining profits are equally shared to the merger participating firms. Do both firms have incentives for such a mergen compared to the equilibrium in (b)? [Mark 0.51 (d) How does the merger change consumer's surplus and social welfare, compared to the espective ones in (b)? [Mark 0.5 (utlic intuition 10%, use of appropriate formulae 40% rrect

Answer 1

Answer (a) If only one of the two firms can introduce the process innovation in its production technology and that the other firm would still produce using the old method and maintains the old marginal cost for its product, in that case, the demand for the technology process innovation would be high among both the firms. However, the firm Natural Salt will be willing to pay more for this innovation (up to 6 per kg ) as it would then bring down its marginal cost in comparison to the marginal cost of Healthy Salt . On the other hand, Healthy Salt’s desire to attain the technological advancement would be lesser in comparison to that of the Natural Salt. Healthy Salt may even not want to buy or get this innovation, as in any case, its marginal cost is lesser than that compared to Natural Salt and is already in a profit situation.

Answer (b) Being the manager of the firm Natural Salt, the advice would be to pay the 1000 euros and introduce the innovation. This is because, Natural salt anyway had a disadvantage over Healthy Salt in terms of its marginal cost. Natural Salt has a disadvantage of 10 Euros per kg. Since Healthy Salt can bring down that level of difference between the marginal cost of the two firms. Healthy Salt would on the other hand may just invest some amount, or nothing at all as it is already at a comparatively advantageous position and would continue to stay so

Answer (c) : If Natural Salt gets the opportunity to pay off 1000 Euros and get in return 500 Euros flat out of the post merger profit, and then further take 50% from the profit earned, then Natural Salt has an absolute better incentive over the Healthy Salt , as Healthy Salt being the firm with lesser Marginal cost , is always at an advantage. But due to this merger, Healthy cost would only get 50% of the profit and Natural Salt being the less profitable firm , would still manage to earn a handsome profit out of the merger due to the set conditions in the merger.

Answer (d) The merger would reduce the consumer surplus to an extent , as these were previously two firms with perfectly alternate products in the market, which were in direct competition. Direct competition is always profitable for the consumers, as it always brings about a situation where, the quality of both the products better better and the prices also fall. However, due to the merger, the merged company would now now attain absolute control of the market selling power and could now thereby start to dictate terms and earn absolute profit and even extra normal profit out of the consumers. The Social welfare would also therefore reduce.