Question

Comprehension: Assume that there are 2 firms producing steel. There is a negative externality due to production causing pollution. Firm 1's output is q1 and firm 2's is q2. Assume that the market price for steel is Ps = 1. Now consider two scenarios : Scenario 1 : Assume that firm 1's cost function is C1(q1) = q1^2 and firm 2's cost function is C2 (q2, q1) = (q2 + 0.75 q1)^2. In short, firm 1's production is not affected by firm 2 but firm 2's production is affected by firm 1, i.e., Firms 1's operation causes firm 2's costs to rise. Scenario 2 : Assume that negative externality works both ways i.e. both the firms face the adverse impact. So assume C1(q1, q2) = (q1 + 0.75 q2)^2 and C2(q1, q2) = (q2 + 0.75 q1)^2, i.e., Firms 1's operation causes firm 2's costs to rise and vice versa. Q.141 What is the equilibrium profit of firm 2 (??2) in the short run, in Scenario 1 ? (1) ??2 = 0.025 (2) ??2 = 0.125 (3) ??2 = - 0.125 (4) ??2 = 0.75

          Comprehension:
Assume that there are 2 firms producing steel. There is a negative externality due to production
causing pollution. Firm 1's output is q1 and firm 2's is q2. Assume that the market price for steel is
Ps = 1. Now consider two scenarios :
Scenario 1 : Assume that firm 1's cost function is C1(q1) = q1^2 and firm 2's cost function is
C2 (q2, q1) = (q2 + 0.75 q1)^2. In short, firm 1's production is not affected by firm 2 but firm 2's
production is affected by firm 1, i.e., Firms 1's operation causes firm 2's costs to rise.
Scenario 2 : Assume that negative externality works both ways i.e. both the firms face the adverse
impact. So assume C1(q1, q2) = (q1 + 0.75 q2)^2 and C2(q1, q2) = (q2 + 0.75 q1)^2, i.e., Firms 1's operation
causes firm 2's costs to rise and vice versa.

Q.141 What is the equilibrium profit of firm 2 (??2) in the short run, in Scenario 1 ?
(1) ??2 = 0.025
(2) ??2 = 0.125
(3) ??2 = - 0.125
(4) ??2 = 0.75

Comprehension:
Assume that there are 2 firms producing steel. There is a negative externality due to production
causing pollution. Firm 1's output is q1 and firm 2's is q2. Assume that the market price for steel is
Ps = 1. Now consider two scenarios :
Scenario 1 : Assume that firm 1's cost function is C1(q1) = q1^2 and firm 2's cost function is
C2 (q2, q1) = (q2 + 0.75 q1)^2. In short, firm 1's production is not affected by firm 2 but firm 2's
production is affected by firm 1, i.e., Firms 1's operation causes firm 2's costs to rise.
Scenario 2 : Assume that negative externality works both ways i.e. both the firms face the adverse
impact. So assume C1(q1, q2) = (q1 + 0.75 q2)^2 and C2(q1, q2) = (q2 + 0.75 q1)^2, i.e., Firms 1's operation
causes firm 2's costs to rise and vice versa.

Q.141 What is the equilibrium profit of firm 2 (??2) in the short run, in Scenario 1 ?
(1) ??2 = 0.025
(2) ??2 = 0.125
(3) ??2 = - 0.125
(4) ??2 = 0.75

Added by Timothy M.

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