Consider the Problem Facing Two Firms in the Fast-Food Restaurant

question 75

Multiple Choice

Consider the problem facing two firms in the fast-food restaurant market, Firm A and Firm B. Each company has just come up with an idea for a new fast-food menu item, which it would sell for $4. Assume that the marginal cost for each new menu item is a constant $2 and the only fixed cost is for advertising.
Each company knows that if it spends $12 million on advertising, it will get two million consumers to try its new product. Firm A has done market research that suggests that its product does not have any 'staying' power in the market.
Even though it could get two million consumers to buy the product once, it is unlikely that they will continue to buy the product in the future. Firm B's market research suggests that its product is very good and consumers who try the product will continue to be consumers over the ensuing year. On the basis of its market research, Firm B estimates that its initial 2 million customers will buy one unit of the product each month in the coming year, for a total of 24 million units.
-According to the information provided, if Firm A decides to advertise its product, it can expect to:

• A) incur a loss of $8 million
• B) have a profit of $4 million
• C) get repeat sales above and beyond the initial two million consumers
• D) increase its market power

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Definitions:

Public Goods

Goods that are non-excludable and non-rivalrous, meaning they can be consumed by one individual without preventing the consumption by others, and without leading to a decrease in available quantity.

Inefficient Allocation

When resources are not optimally distributed, leading to a situation where it is possible to improve at least one person's well-being without worsening any other's situation.

External Effects

Consequences of economic activities on unrelated third parties; can be positive (benefits) or negative (costs).

Knowledge Creation

The process through which new ideas, information, and understanding are generated, often leading to innovation and improvements in technology or methodology.