Final answer:
In this case, we can determine if products 1 and 2 are complements or substitutes by calculating the cross-price elasticity of demand. To find the equilibrium prices, volumes, and profits, we can solve for the Nash equilibrium by setting up the profit functions and best response functions for each firm. The own and cross-price elasticities, as well as diversion ratios, can be calculated using the equilibrium prices and volumes. If firm 1 drops its price, firm 2 would raise its price to take advantage of decreased competition. If firms 1 and 2 merge, the new equilibrium prices, volumes, and profits would be determined by the merged entity's strategy.
Step-by-step explanation:
Complements or Substitutes:
Products 1 and 2 can be considered complements or substitutes depending on the value of the cross-price elasticity of demand. If the cross-price elasticity is positive, it means that an increase in the price of one product leads to an increase in the demand for the other product, indicating that they are complements. On the other hand, if the cross-price elasticity is negative, it means that an increase in the price of one product leads to a decrease in the demand for the other product, indicating that they are substitutes. In this case, we can calculate the cross-price elasticity of demand to determine whether they are complements or substitutes.
Equilibrium Prices, Volumes, and Profits:
To find the equilibrium prices, volumes, and profits, we need to solve for the Nash equilibrium. In this case, each firm chooses the price that maximizes its profit given the prices chosen by the other firm. We can start by setting up the profit functions for both firms, taking into account their respective demand curves and costs. Then, we can find the best response function for each firm, which represents the price that maximizes its profit given the price chosen by the other firm. By solving for the intersection of the best response functions, we can find the Nash equilibrium prices, volumes, and profits.
Own and Cross Price Elasticities and Diversion Ratios:
The own price elasticity of demand measures the responsiveness of quantity demanded to a change in the price of the same product. The cross price elasticity of demand measures the responsiveness of quantity demanded to a change in the price of another product. Diversion ratios measure the proportion of customers from one firm who switch to the other firm in response to a change in price. To calculate these measures, we can use the equilibrium prices and volumes and apply the relevant formulas.
Price Adjustment by Firm 2:
If firm 1 drops its price, it reduces the demand for its own product and increases the demand for firm 2's product. Firm 2, in response, has an incentive to increase its price to capture some of the demand that was diverted from firm 1. This is because firm 2 can increase its profits by taking advantage of the decreased competition from firm 1. Therefore, if firm 1 drops its price, firm 2 would raise its price.
Merger of Firms 1 and 2:
When firms 1 and 2 merge, they form a single entity that no longer competes with itself. As a result, the new equilibrium prices, volumes, and profits would be determined by the merged entity's profit-maximizing strategy. This would involve considering the combined demand curve, costs, and any potential synergies or efficiencies resulting from the merger.
Beneficiaries of the Merger:
The beneficiaries of the merger would depend on the specific circumstances of the market and the merger itself. Generally, the merged entity could benefit from economies of scale, increased market power, and potential cost synergies. However, the impact on consumers and other competitors would vary depending on factors such as the level of competition in the market and the ability of the merged entity to exercise its market power.