5. Two firms, Alpha and Beta, are competing in a market in which consumer prefer

Question

5. Two firms, Alpha and Beta, are competing in a market in which consumer preferences are identical. Alpha offers a product whose benefit B is equal to $100 per unit. Beta offers a product whose benefit B is equal to $75 per unit. Alpha’s average cost C is equal to $60 per unit, while Beta’s average cost C is equal to $50 per unit.
i. Which firm’s product provides the greatest value created?

ii. In an industry equilibrium in which the firms achieve consumer surplus parity, by what dollar amount will the profit margin, P-C, of the firm that creates the greatest amount of value exceed the profit margin of the firm that creates the smaller amount of value?
iii. Compare this amount to the difference between the value created of each firm. What explains the relationship between the difference in profit margins and the difference in value-created between the two firms?

Explanation / Answer

1. Firm A. 2. Firm A's margin will exceed Firm B's margin by $15 3. Essentially, firm B takes $50 of materials and turns it into $75 of benefit. However, firm A can use an additional $10 to create an additional $25 of benefit. Firm B is creating value of 75/50 = 1.5, while Firm A is creating value of 100/60 = 1.67. This difference is explained by increasing marginal returns to value.

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