Managerial Economics & Business Strategy 8th Edition by Michael Baye,Jeff Prince

Exercise 19

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 consumers' 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:

GearNet and NetWorks each use labor, materials, and machines to produce output. GearNet 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:

Reports from industry experts suggest that NetWorks' 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 GearNet should produce 250 hubs or 500 hubs.