High School

Assume that we have an entry situation like that in the Judo Economics example. There is an incumbent firm (I) and a new entrant (E). Now we will look at the outcome if the entrant is at a disadvantage.

The incumbent has constant marginal costs of production of $100, while marginal costs for the entrant are $120 per unit. There are 100 identical buyers who are willing to pay $200 for the incumbent’s product, but only $160 to buy from the entrant. Overall, buyers will pay $40 more for the incumbent’s product. Any consumer can buy from the incumbent, but only those targeted by the entrant can buy from the entrant. Those consumers targeted by the entrant can choose to buy from the incumbent or the entrant and will choose the lowest price (with the incumbent winning ties).

At the first move of the game, the entrant decides how many consumers (N) to target and sets a single price (P) to those targeted consumers. The incumbent then sets a single price for all 100 consumers, deciding to defend the market or accommodate the new entrant. Consumers then purchase the good.

How many consumers should the entrant target, and what is the optimal price? What are the incumbent’s profits in this scenario?

Answer :

The entrant should target 40 consumers, and the optimal price for the entrant is $160.

To determine the optimal number of consumers the entrant should target, we need to consider the marginal costs and willingness to pay. Since the entrant's marginal cost is higher than the incumbent's, it is advantageous for the entrant to target consumers who are willing to pay a price closer to its marginal cost.

If the entrant targets more than 40 consumers, it would have to set a price lower than $160 to be competitive with the incumbent, resulting in lower profits. On the other hand, if the entrant targets fewer than 40 consumers, it would not be utilizing its full capacity, leading to missed opportunities.

By targeting 40 consumers, the entrant can set the price at $160, which matches the consumers' willingness to pay. This strategy ensures that the entrant captures the consumers who value the product the most and maximizes its profits.

The entrant should target 40 consumers and set the price at $160 to maximize its profits. The incumbent's profits can be calculated by subtracting its constant marginal cost of $100 from the price paid by all 100 consumers, which results in a profit of $10,000 ($200 - $100) per unit sold.

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