The (Leontief) production technology for both the entrant and an incumbent requires one unit of labor and one unit of capital per unit of output. Suppose that the wage rate is w and the rental price of capital r . Then the cost of production is c = r + w. In the short run the costs of capacity (capital) are sunk.
(a) Is this technology characterized by economies of scale?
(b) What is the short-run marginal cost function?
(c) Suppose that the incumbent has sufficient capacity such that at p = w she can produce the market demand. If the price postentry is w, would an entrant enter? Should the price postentry reflect w? Equal w?
(d) Why might it not be profit maximizing for the incumbent to have that much capacity?
(e) How much capacity would be installed in the long run if the market was perfectly competitive? Why?