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

question 114

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 B decides to advertise its product it can expect to:

• A) have a profit of $36 million per year
• B) incur a loss of $12 million per year
• C) have a profit of $48 million per year
• D) exit the industry

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