Note: The question is actually asking you to analyze the conditions needed for McDonald's profits in China to decline after Ed Bear arrives, so:

Why is 1 a necessary assumption? If the market capacity expands, McDonald's profits in China are not necessarily declining, so 1 is necessary

But if Ed Bear encroaches on just the portion of the original market outside of McDonald's, McDonald's profits may not necessarily decline significantly. Didn't you say that out loud? For that very reason you stated, 2 is also necessary