Question

Two firms (Natural Salt and Healthy Salt) compete in the market for Himalayan table salt Consumers 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 Q 450-2P, where Q is kgs and P is Ekg. The initial marginal cost of Natural s 506/kg. 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 margi to 44 and Healthy Salt's marginal cost to 34 (a) Consider that only one of the two firms can introduce the aforementioned process marginal cost. How much would each firm be willing to pay so as to introduce the aforementioned process innovation in its production technology? IMark 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. IMark 1.51 (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 rofits (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 merger, compared to the equilibrium in (b)? IMark 0.5 (d) How does the merger change consumer's suplus and social welfare, compared to the respective ones in (b)? IMark 0.5

Answer 1

Answer (a) : As per the situation, Natural Salt and Healthy Salt products are perfect substitutes for each other in the market. Therefore, what we understand from the further given situation is that Natural Salt firm is making less profit from the sale of the same quantity of product as compared to that of the Healthy Salt firm, as its marginal cost of production is higher as compared to that of the Healthy Salt firm. If only one among the two firms can introduce the mentioned innovation process of technological advancement, and the other would have to still continue producing with the old technology, in that case, the demand for this technological set up would be higher at the end of the Natural Salt company. This is because, Natural Salt is aware that it is already making loss in comparison to the Healthy Salt firm as per the old set up. Now, the Natural Salt firm would want to cover up the loss incurred or to be incurred in the future. It would be ready to pay u to the total profit it can make by the new set up, i.e. up to 6 Euros per kg of Salt. Whereas, the Healthy Salt company is in no dire need to implement this innovation. It may only want to implement it to increase its already existing profit from the market. It would therefore want to pay lesser, i.e. up to 4 Euros per kg of Salt.

                                    Answer (b) : If the Natural Salt firm has the option to pay 1000 Euros in the introduction of this process, it is advisable to pour in the total investment in the implementation of the technological advancement. This is because, the Natural Salt company is already incurring a comparative loss in comparison to that of the healthy Salt company. If the situation continues further, the Healthy While Salt may in future introduce a new product at a far lesser cost to run away with the business. Therefore, it is advisable to bridge the gap of profit as early as possible. Moreover, the investment that would be done , i.e. 1000 Euros, can be accrued back in the form of better profit in a span of few months or years. In the case of Healthy Salt firm, it is also advisable to invest the amount, as this would lead to its profit margin getting even better as compared to the Natural Salt company. If the Healthy Salt firm can put in this investment, its marginal cost per kg of Salt would be 34,Euros which will increase its profit margin by a huge amount.

                                  Answer( c) : This merger between the Natural Salt and the Healthy Salt firms will being profits for both firms, however, the Natural Salt firm would be at a better placed position. This is because, the Healthy Salt would in the firm place put in the money and get back half of it back from the profit. Then in the subsequent profits, they share the profit at 50% each. This profit share would be unlimited, and the Natural Salt firm would gain the benefit by paying next to nothing, however, the Healthy Salt firm would have to invest a substantial amount of money and it would get back the returns in some time which would also be a non-incisive return for the Healthy Salt firm.

                                  Answer (d) : The merger as described above has direct impact on the consumer surplus in the market. After the merger, the firms may decide to control the market of Salt in their own terms and may either increase or decrease the price of the Salt depending upon the profit earned. It is observed that the profit earned from the Salt market is never negative, and therefore there would be no question of reduction of prices. Therefore, the consumer surplus might be negative, i.e. the consumer may have to pay more for the same kg of Salt now as compared to earlier. Social welfare would thereby also get affected indirectly. Since the consumer surplus would be lesser, the welfare of the society would also be directly impacted, and it would be poorer in a gradual span of time.