ECON 2350 Lecture Notes - Lecture 10: Best Response, Marginal Revenue, Marginal Cost
27 Feb 2017
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Document Summary
We have now examined how the follower will choose its output given the choice of the leader. We turn now to the leader"s profit-maximization problem. Presumably, the leader is also aware that its actions influence the output choice of the follower. This relationship is summarized by the reaction function f2(y1). Hence when making its output choice it should recognize the influence that it exerts on the follower. The profit-maximization problem for the leader therefore becomes. Max y1 p(y1 + y2)y1 c1(y1) such that y2 = f2(y1). Substituting the second equation into the first gives us. Note that the leader recognizes that when it chooses output y1, the total output produced will be y1 + f2(y1): its own output plus the output produced by the follower. When the leader contemplates changing its output it has to recognize the influence it exerts on the follower. Let"s examine this in the context of the linear demand curve described above.
