Question about Managerial Economy

Question 1: (15 points) Oligopoly. Suppose you own a gas station and the only other gas station in town is across the street from your gas station. Explain in general terms the two outcomes that you might expect to happen—in other words, if the gas stations collude, how would that differ from the gas stations competing? How would the profit of your station compare between the two outcomes and how would the prices charged to the consumers compare? Give several reasons why collusion would be more likely in the above gas station case as compared with a farmer’s market that meets monthly and attracts approximately ten to twenty farmers. Explain each reason. Question 2: (15 pts) (Hint, this is very close to a couple of the homework questions on MindTap) Assume that two companies (C and D) are duopolists that produce identical products. Demand for the products is given by the demand function

P = 450 – 2QC – 2QD Where QC and QD are the quantities sold by the respective firms and P is the selling price. Total cost functions for the two firms are

TCC = 10,000 + 75QC TCD = 8,000 + 80QD Assume that the firms act independently as in the Cournot model and find the long-run equilibrium output for each firm and the selling price. What is each firm’s profit? Question 3: (20 pts) (based on questions 1-3 of Chapter 13 homework) Suppose two firms are in competition with each other. They can either try to have a high level of competition or a low level of competition, with each firm deciding independently whether to compete with a high or low level of intensity. If both firms choose a low level (low amount of advertising, lower amount of production), both firms would receive $10 million in profits. If one firm chose a high level of competition and the other chose a low level, the firm who chose a high level of competition would receive $12 million, while the other firm who chose the low level of competition would receive $6 million. If both firms chose a high level of competition, each firm would have a profit of $8 million.

a. For this situation, construct a payoff matrix b. Determine the Nash Equilibrium (or equilibria, if multiple occur) c. Does either firm have a dominant strategy? Why or why not?

Question 4: (15 pts) An incumbent firm (monopolist) in an industry decides to make it known that they will compete aggressively against any potential entrants if they decide to enter the industry. Specifically, the incumbent firm threatens to lower the price so that the entrant would lose money (make negative profit).

a. If the firms had the same cost structures and each firm would produce the same amount of output if the potential entrant actually entered the market, is this a credible threat? Why or why not?

b. If the entrant faced higher costs (likely in many situations, as they would not have the expertise and practice at making the products) could this threat be credible? What would need to be true? (Hint: the kernel of the answer is in Question 3, though it needs to be slightly expanded)

Question 5: (20 pts) This example is a little simplified, but consider a package delivery company who only offers two different shipping times: Overnight arriving by 9 AM the next day, and a three-day delivery time. The price for the overnight is $50 for a particular package and for the same package the price for the three-day delivery time is only $20. If we consider just two groups—business people/firms in one group and consumers in a second group— discuss how the pricing tactic is an effective use of price discrimination. In other words, which group has the higher willingness to pay for a particular type of shipping and why does the pricing strategy effectively segment the two groups so that the group with the higher willingness to pay is likely to choose to pay more.

Question 6: (15 pts) DVDs used to have ‘regional encoding’, in which the location code for the DVD player had to match the location code for the DVD in order to play the DVD, otherwise the player would not play the DVD. For instance, a DVD player with the North American code would only play disks (DVDs) with the North American code, and not play any disks with a European or an Asian code. Explain how this allows for price discrimination between markets. Does this particular segmentation work well for the pharmaceutical drug industry? Why or why not? Question 7: (10 pts extra credit) Some companies offer bundles of Cable, Internet, and Telephone. Explain how the bundle can result in more profit than offering the three items individually. You could consider the following: the cost to each product is $5 per person. There are three people, who have willingnesses to pay of the following: Person A: $15 for cable, $12 for Internet, and $7 for Phone, Person B: $10 for cable, $16 for Internet, and $10 for Phone, Person C: $8 for cable, $10 for Internet, and $13 for Phone. What price would be set to maximize the profit if each good were sold separately and what is that profit? (Hint, or cable, that price would be either $8 and all three would buy, $10 and only A and B would buy, or $15, and only A would buy). What is the total profit from selling all three goods individually? Are there profitable transactions that could be made that aren’t under this individual pricing model? What price would the bundle be set at and what would the profit be for the bundle? (hint, person A would be willing to pay up to $15 + $12 + $7 for the bundle if that is the only option—buy the bundle at that price or not)