ECON 400 Assignment 3 answers

ECON 400 Assignment 3 answers - '3-“ Walt/gem 9%A’...

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Unformatted text preview: '3 -“ Walt/gem 9%A’ Nl’rfv‘lw /’A:‘f5! ‘65 5.3% ME V \/ “Ix/rim fiézgl 5Q £303 @753??? GJS%(Q)”§”Q j é; {M‘wa émfifivfiffi f 0 if .3 120 Z QUO VA > PW»; VI A“ Pv’zé 6959‘? fifiwmg fly? p4£fy§fi4+1 A. K Q10) (/K/{w éy4mil§wam£§z§§j 03% a fly “.2 2w; ([3: «249] 2w [WW/2:}? _/ 2) “mm QL/an ’62)? ~ .19 5%.) j bf IQA) F}; V03}; 2‘40 (03;: a! g 531% “if fly :3? 0%, (j 0% @r- af‘ M PM. 9?? m gwg :7 my (3% #5ng fin 2W 5% Assignment 3 Question 3. Quality—Augmented Hotelling model T wo firms, A and B producing qualities, 5A and 53 respectively. Consumer value the goods according to: HA : — 1:10.311 —- pA 11.3 = [1' —~ [(1 ~;1:)]SB —~ In; Consmners buy one unit of A or B but not both (and not neither (711.4 . “ '.', . .' ' ' Tm = I — (5.1,. > 0 so ut1hty'15 111c1ea51ng in quality. .9 s affect ros‘s valuation vert1cal chfferentiatlon : 5/ ‘17 B A => 'I‘SA T 7* (5A — 83) measures vertical differentiation 3A, .38 also affect travelling costs (horizontal difi'erentia— tion): SAT => #173ng (b) Given 5A, 35‘ in order to find the demand functions for the two finns: Step 1: Find indifferent consumer : (7' — — 1),; = [1' — [,(1 — SB — pB Hence demand for the two firms: qA(zanels-B):r;=m+ SB _M [a a 11 " t(8/1+SB) SA+SB t(5’A+SB) A 7’ 811—3 3 ’11—) QB (1)/111)BES/17¢SB) :1 — :p : 1 _ (__B_) _ B p 13 t(5A+SB) 811+83 t(SA+SB) (c) In order to find the price equlibrium. The firm profits: A 7‘ (5A - 53) SB m R PB H. ,; ,s,s 2913;: + ,_ A (p4 M A B) 11 FA ['5 (8/1 + 83) 3A + 83 t(3/l + 83)] 7‘ (8A — .93) 83 + PA — PB ] H3 PEP/1,511,813 :1) 1—1,: = )3 [1- - ( ) B( ) I t(5A+ SB) SA+83 USA +33) Hence firm A’s problem: maxHA (13/1;va 8/1753) m FOC: BHA a: 03? 0 r I A— : ' 010A 327A :> 7' (5A - 6‘3) + 93 _ PA “ PB __ P4 = 0 t(8/1+83) SA+9B («SA-I593) f(54+93) 7' 5 — s 9 2 — J :>(A B)+ B _29A 13:0 t(sA + 83) 811+ SB USA + 9.8) firm B’s problem: niggxflg (PB; m, 8A, 83) FCC: 0113 A d? — : 1 — :1: ) — — 0 0223 1 3012B 7‘ (8A — SB) ‘33 I711 "' p13 p3 => 1 — — + — = 0 “911+ ‘33) 8A + 33 79(3/1 + 313) ’ (911+ ’93) 7* (3A — 33) 3A 12/; — 2123 => — + + = 0 {(9/1 + '93) 311+th 75(9/1 + SB) Therefore in order to solve for NE: 'I'(.5AmsB)+ 33 _ 2pA~pB :0 } [(SA-I-SB) 5A+SB t(sA~+-HB) 1 _ 7'(5A=-3B) _ 8:2 + 2.3425 _ 0 [(5144-53) 3144-83 [NA-+33) 2’) — ) ') — 2 ) :> [A 13 Z 1 + IA 13 15(3A+SB) t(sA+33) :> 2PA — PB ~ PA + 21713 25(5/14— SB) =>PA +123 = t (3/1 + 83) ) . 1(8/1-I-SB) t(S/1+SB) =1 219A +pA 1 _ 7 (5A — 93) SB t(9A+sB) “SA-+93) 911+93 2”“ I Hm;— 93) + gsB+ I (9,13— 93) Z>pA Z t(s*A—r:253) + Mrs/12— SB) =>p3 =1:(8A+ SB) “ [(9/1 i283) " I (9A3— SB) 2””? : t(29/13+33) + 7' 9,1) We assume that [(3/1 + 283) > 7‘ (5A — SB) t(28/1+53)>7‘(sB — 8/1) which are satisfied if 133 — [ml is not too big. Therefore the equlibrium prices: t 1.1 2!. ,. 3/ _(. m: (51+ SB)+'(5A SB) and 3 3 t 25 + s 7' s —- 3‘. p3: ( A3 19+ (33 a) and therefore pA — p3 : t (8A + 233) + 7' (8A — SB) — “2811 + 85) — 7‘ (SB — SA) 75 (M + 83) 3f: (5/1 + 83) (27' — 25) (SA — 83) 3“ (M + 513) and it: 7'(s,1 —83) + 83 __ (27' == (3A — 33) ' t(8A+.S‘B) SA’i‘SB (SA-F83) _ '1" (5A — 33) — (27' ~ (8A —— 83) .93 — + 3t(s/1+SB) 5/1 + 33 SB (7‘ — 15) (3A — SB) SA + 83 315 (SA + 33) 7' (83 — 5/1)+t(3,1+ 253) 3t (3A + 83) l | (d) Profits are given by: 7' 33 — 8A +t 8/1 + 233 HMS/1:83): (t (5.4 + 2313) + '7’ (8A — 53)) 1 1/ 2 l 5 1 (TBA — 7'35 + tsA + 22583) (7’83 — 719A + tsA + 2633) 9 l )—Ceu : — —_ C 5 ( /l) t 2t,- 2— —/, 2 : (9/1 + $5) (rs/1 r93) _ C(SA) 925 (SA —|— .33) _ t(28A-+-83) 7'(SB—SA) 7‘(93- 9A)+'l;(.5A+293) 113(8‘4’83)— < 3 + 3 1 31‘ (9/1 + 83) Assuming that 3A 2 33 = s equilibrium prices are p14 2 p3 2 ts and profits become: 1 (3t3)2 st H, 2H s,s:— —Cs=~—Cs Aes m,> m % m 2 <> Note that in this case the model is identical to the simple Hotelling model with 7' : ts. The Therefore, ffl=5—ce> ()s 2 Hence profits are increasing in quality if é— C’ > 0 and decreasing in quality if g — C’ < 0. Supoose that — C’ (s) > 0 for some 5. Since C” > 0, as 3 increases, the effect on profts becomes negative. The profit function is concave in quality, therefore profits are maximized at a positive quality level. In this model, the firms offering above minimum symmetric quality can increase their profits (the higher quality allows them to charge a, higher price). Note: Suppose that the question said that the firms can choose the quality they offer, and suppose that the firms determine the quality in 4 the first stage and choose prices in the second stage. In order to find the equlibrium s, we would have to first find the F00 without imposing symmetry and then use symmetry in the FOC. The FCC for A: 611A _ 1 (3A + 83) [2 (MA + 2t33)2 — 2 (TS/1 — 7‘83) +t — 7'] — (ts/1 + 27533)2 + ('rsA —- 'r'sB)2 ( (98A 9t (3A + 33)2 - Now assuming that in equilibrium 3,; 2 SB 2 3, the FCC becomes: 1 23 (2 (31:9)2 + 'l; — 7‘) — (3ts)2 _ 1/ t : 9t 482 C (9) 02> l 93152 (45- — 1) + 21, — 27' , Q—F “C (S)—0 :> [(43 — 1) 15—7" — _(}I t. 2 4 + 19th ’ (5) 0:5 This can in principle be solved to find the equlibrium 3, given cost function C . (e) Now 11:11:7'+8A — ta: —pA ’l.l,B='I‘+ $3 - t(1 — :13) —pg This is the same model as having different gross valuations for the two goods. Simply let m = 1' -|— 3,; and r3 : r + $3 in the model we solved before. The solution is (refer to class notes): TA — 7‘3 8A f 633 :t+ =t—I— , p11 3 3 "‘A - TB : {I _ 8A —* SB 3 ’ 3 where 39A 2 p3 = t if quality is symmetric. Therefore, in this model they cannot charge a higher price if they offer symmetrically higher quality. Hence firm profits: P3=t- I; 31—55 2 s —s HA(SA«,SB):§+—( 118;» + A3 B — C(SA) In this case when qualities are symmetric gross profits doe not depend on qualify. Therefore, profits are decreasing in quality for as long as consumers have a large enough gross valuation to be in the market. '15 rH H(s, s) : i — C(s) :> = —C’ < 0 Suppose firms Choose their quality in the first stage. Firm A’s FOC OIL/l H 2 (SA ~— 33) l I M an — 18-]; + 3 0 (19A) _ 0 (SOC: § — C”(sA) < O Invoking symmetry the equilibrium quality solves — 0(5) 2 0. T hus, the firms would choose to ofi'er more than minimum quality, even though their profits decrease in equlibrium. This is again a Prisonerls Dilemma Situation for the firms. #3 (a) Calculate the optimal contract {(qL*, tL"), (qH*, tH*)} under full information. Maximize 11L = tL — 0.5qL2 subject to BLqL — tL = 0. Since tL = 16111, substitute this in the profit to obtain TIL = 16qL — 0.5qu. Maximize this with respect to qL to get qL* = 16. Then tL* = $256. Maximize TIH = tH — 0.5qH2 subject to 64H — tH = 0. Since tH = 20qH, substitute this in the profit to obtain 11H = 20qH — 0.5qH2. Maximize this with respect to qH to get qH" = 20. Then tH* = $400. ' (b) Calculate the optimal contract {(qL**, tL**), (qH**, tH**)} under incomplete information. We know that qH** = qH* and that only the IRL and I CH constraints are binding. So qH'k‘k = 20, 16qL _ ti = 0, _‘ tH = _ ii. The firm’s profit is given by 1': = 80[tL — 0.5qu] + 20[tH — 0.5qH2]. From the IRU we get tL 2 16th. Substituting it into the [CH and solving, we get tH = 20(qH — qL) + 16qL. Substituting for tL and tH as well as qH, we obtain 1': = 80[16qL — 0.543] + 20[400 — 4% — 0.5(400)]. ll Maximizing with respect to qL, we get qL** = 15 and tL** = $240. Then get qH** 20 and tL** = $340. 0 Question 64’ (i) Firm A takes q]; as given and chooses qA to solve 3 max RAMA. £113) = (60 — 3 L14 — q") (1.4- «1.4 Similarly, Firm B takes (1,; as given and chooses (73 to solve A 3 111'“ Malibu LIE) = (60 — 3113 — (Li) (13- ‘11} (ii) A's first—order condition for a maximum is 0 = EMA/0“ = 60—3q,‘ —q3. Similarly, 0 = Una/0113 2 6‘0 — 3qB - (1,1. Hence, the best response functions are downward sloping and are given by qA 2 Rm”) 2 20 — q?“ and q” = 123014): 20 — (iii) Solving the two best—response functions yields qA = (“3 = 15. Substituting into the demand functions yield 1,7,4 = 1113 = 45/2 = 22.5. Substituting into the profit functions yields 7” = 7r}; = 675 2 = 337.5. (iv) Solving for £14 and q]; from the above inverse demand functions obtains 6 4 6 4 £14 =24-Ep,4+gp3 and 93:24—EPB‘l'gPA- (v) Firm A takes p3 as given and chooses p,‘ to solve _ 6 4 1113X7TA(PAy1)B) = p14 24 — -p_4 + FPB - 17A 5 o Firm B takes p4 as given and chooses pH to solve 6 4 max WB(P.4,1JB) = p3 (‘24 — — pa + — m) ~ PM 5 5 (vi) A's first—order condition is: 0 = anti/612A 2 4(30 — 31),; +pB)/5. B's first—order condition is 0 = Bug/tips; = 4(30 — 3113 +pA)/5. Hence, the upward sloping best—response functions are 1 1 PA = R.4(PB);10+TPB and P8 = RBlPA)=10+§I-’A- 3 (vii) Solving the two price best-response functions yield 7);; = [)3 = 15. Substituting into the above direct demand functions obtains (1,4 = qB = 18. The resulting profits are 7m 2 rm 2 270. (viii) The price game yields a lower price than the quantity game (15 versus 22.5). There— fore, consumers buy 6 more units of each brand (36 versus 30). The price game yields lower profit to each brand—producing firm (270 as opposed to 337.5). This means that a price game results in a more intense competition relative to a quantity—setting competition game. 17 ...
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