Question

Rippin’ Good Cookies is based in Ripon, WI. They give free samples! As of January 2013, Girls Scouts of Wisconsin Southeast became their main competitor after adopting a direct sales model. Girl Scouts now bring cookies door-to-door rather than only accepting orders for later delivery. Suppose the inverse market demand for cookies is given by Q = 3600 − 6P and initially both produce at equal marginal cost, c0.

1. Find the price that each should set if they compete as Bertrand firms (in price).

2. Assuming initially c0 = 375. Suppose now that Rippin’ Good invests heavily in R&D and reduces its unit production cost to c1 = 200. What price should Rippin’ Good set and how is the market divided between them and Girl Scouts? Is this a large or small innovation?

3. Suppose now that Rippin’ Good invests heavily in R&D and reduces its unit production cost to c2 = $100. Assuming initially c0 = 375, what will be Rippin’ Good’s optimal price and quantity after the cost-saving innovation? Is this a large or small innovation?

Answer 1

1. In Bertrand model each firm charges its price equals to its marginal costs.

Since both the firms have equal marginal costs, C₀. So both the firms should charge price, P = MC =C₀.

2. Since the marginal cost of Rippin’ Good is less than that of Girl Scouts that is why Rippin’ Good will set its price a little less than that of Girl Scouts (say P = $374). Now the price of Rippin’ Good is less, so all the consumers will buy cookies from it and nobody will buy anything from Girl Scouts since they are charging a greater price.

So the Rippin’ Good will capture the whole market and Girl Scouts will get nothing.

And it is a large innovation.

3. Similarly when C₂ =$100, optimal price of Rippin’ Good will be P=$374 and quantity, Q = 3600 – 6P = 3600 – 6*374 = 1356

And it is a large innovation.