In the wake of expanding demand for their cars, Japanese manufacturers, Toyota and Honda, have expanded production at existing factories and…

In the wake of expanding demand for their cars, Japanese manufacturers, Toyota and Honda, have expanded production at existing factories and established new plants in North America. In June 2006, Honda announced a new $550 million factory, creating 2,000 jobs, at Greensburg, Indiana. Meanwhile, U.S. manufacturers, General Motors and Ford, face falling demand and offered incentives for workers to quit, so that they could reduce production capacity.

(a) Suppose that, in the short run, Ford and General Motors compete on price to sell differentiated products. If GM increases price discounts, how should Ford adjust prices?

(b) Use the Cournot model to relate the expansion of capacity by Toyota and Honda to the contraction in capacity by Ford and General Motors.

Suppose that Toyota exercises capacity leadership. How would that affect your explanation in (b)?