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Unformatted text preview: ECON 468: Industrial Organization Problem Set 4 Due date: May 8th 2008 May 8, 2008 1. Consider the problem of a cofeeshop who wants to set the price and the optimal size of cup of coffee. The market is composed to two types of consumers i ∈ { L,H } with the following utility from buying a cup of size q : u i ( q ) = θ i q p ( q ) , where θ L < θ H and p ( q ) is the price of cup of size q . The proportion of consumers of type H in the population is 1 / 2 (the other half is of type L ). Moreover the cost of producing and selling a cup of size q is given by: C ( q ) = 1 2 q 2 . (a) Assume that the store’s owner is constrained to offer only one type of cup (i.e. q u ), and is not able to price discriminate between consumers. What is the optimal cup size and price such that both types of consumers are buying the good? (hint: solve for the maximum price such that both participation constraints are satisfied and then maximize the supplier’s profits to find the optimal cup size). Only PC L will bind: θ L q = p . Substituting in the profits of the firm the optimal size solves: max q θ L q 1 2 q 2 q u = θ L The optimal solution is therefore: ( p u ,q u ) = ( θ 2 L ,θ L ) . (b) Assume now that the owner is perfectly able to discriminate across consumers. What is the optimal cup size and price offered to each consumer type?...
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This note was uploaded on 08/08/2008 for the course ECON 468 taught by Professor Houde during the Spring '08 term at University of Wisconsin.
 Spring '08
 HOUDE
 Perfect Competition

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