Cost reduction and the Herfindahl and Lerner indexes.        Consider an industry where demand has constant price elasticity and firms compete in output levels. In an initial equilibrium, both firms have the same marginal cost, c. Then Firm 1, by investing heavily in R&D, manages to reduce its marginal cost to c′ , c; a new equilibrium takes place. (a) What impact does the innovation have on the values of H and L? (b) What impact does the innovation have on consumer welfare? (c) What do the previous answers have to say about L as performance measure?

Question

10.7. Cost reduction and the Herfindahl and Lerner indexes.        Consider an industry where demand has constant price elasticity and firms compete in output levels. In an initial equilibrium, both firms have the same marginal cost, c. Then Firm 1, by investing heavily in R&D, manages to reduce its marginal cost to c′ , c; a new equilibrium takes place.

(a) What impact does the innovation have on the values of H and L?

(b) What impact does the innovation have on consumer welfare?

(c) What do the previous answers have to say about L as performance measure?

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Market hypothesis

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