Statistics

At a time when demand for ready-to-eat cereal was stagnant, a
spokesperson for the cereal maker Kellogg’s was quoted as saying,
“… for the past several years, our individual company growth has
come out of the other fellow’s hide.” Kellogg’s has been
producing cereal since 1906 and continues to implement strategies that
make it a leader in the cereal industry. Suppose that when Kellogg’s
and its largest rival advertise, each company earns $0 billion in
profits. When neither company advertises, each company earns profits of
$8 billion. If one company advertises and the other does not, the
company that advertises earns $48 billion and the company that does not
advertise loses $1 billion. Under what conditions could trigger
strategies be used by these firms to support the collusive level of
advertising?

You are the manager of GearNet and must decide how many Internet hubs to
produce to maximize your firm’s profit. GearNet and its only rival
(NetWorks) sell dual speed Internet hubs that are identical from
consumer’s perspectives. The market price for hubs depends on the
total quantity produced by the two firms. A survey reveals that the
market price of hubs depends on total market output as follows:

Combined Hub Protection of GearNet and NetWorks Market Price of Hubs
(Per Unit)

500 units $120



750 units 100

1000 units 90



GearNet and NetWorks each use labor, materials, and machines to produce
output. Gear Net purchases labor and materials on an as-needed basis;
its machines were purchased three years ago and are being depreciated
according to the straight-line method. GearNet’s accounting
department has provided the following data about its unit production
costs: GearNet’s Unit Cost for an Output of:

Item 250 units 500 units

Direct Labor $40 $40

Direct materials 30 30

Depreciation charge 80 40

Reports from industry experts suggest that NetWork’s cost structure is
similar to GearNet’s cost structure and that technological constraints
require each firm to produce either 250 hubs or 500 hubs. Identify the
costs that are relevant for your decision, and then determine whether
Gear Net should produce 250 hubs or 500 hubs.