Question

Consider a model with two countries, the US and Japan. The US h

as one film maker, called

Kodak. Japan has a competitor company, called Fuji. Kodak can p

roduce film at a constant

marginal cost of $4 each. Fuji can produce film at a constant m

arginal cost of $8 each. Within

each country, the demand for fil

m is given by the same demand c

urve:

P

=

20

– 2*

Q

where

Q

is the number of film demanded in that country per month, and

P

is the price per

film in that country.

(i) Suppose initially that both economies are in isolation. Wha

t will be the price and the

quantity sold in each country?

[Tip: The marginal revenue in ea

ch country is MR = 20 – 4*Q ].

(ii) Suppose that we now have fr

ee trade between the two econom

ies. There is no cost to

transporting the film across bord

ers for either firm. Suppose t

hat the two corporations set

their quantities in each market simultaneously. For any given q

uantity

qF

that Kodak expects

Fuji to sell in the US market, find the profit‐maximizing quant

ity

qK

that Kodak will sell in

the US market. Using your answer

, draw Kodak’s reaction functio

n for the US market.

[Tip: The marginal revenue of Kodak in the US is MR = 20 – 4*qK

– 2*qF ].

(iii) Using logic parallel to (ii), draw Fuji’s reaction functi

on for the US market on the same

diagram.

[Tip: The marginal revenue of Fu

ji in the US is MR = 20 – 2*qK

– 4*qF].

(iv) Assume that each firm correctly guesses how much the other

will produce in each

market. (Tip: find where the reaction curves cross). What will

be the price charged and the

quantity sold in the US market?

(v) What is the effect of trade

on consumer surplus in the US?

Answer 1