Ec5p042007-1 - Economics 5 Principles of Microeconomics D...

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Economics 5 D. Richards Principles of Microeconomics Fall, 2007 Fourth Problem Set 1. A few years ago an article in the Wall Street Journal (See M. Maremont, "Braun, Sonicare Brush Up On their Legendary Feud", April 30, 1999, p. A1.) describes how the two dominant makers of toothbrushes, Braun and Optiva, (each has about 35% of the market) battle constantly over whose toothbrush product is best. Each company spends relatively large amounts in brochures, promotions, and dental care journals touting the superiority of their bristles. Indeed, in one round of the battle, Optiva used its brushes on the teeth of dead pigs to demonstrate both their cleaning effectiveness and their ability to massage gum tissue. Not to be outdone, Braun responded with a similar test on live pigs—claiming that these tests showed its own toothbrush to be just as good and, moreover, quite gentle. (Apparently, none of the live pigs squealed.) Analyze this advertising war using the matrix below. In each box, the first entry indicates the profit of Braun and the second entry indicates the profit of Optiva (each in millions). What is the Nash Equilibrium of the game? Is the conflict in the mutual interest of each company? What makes it difficult for either Braun or Optiva to “demilitarize” i.e., reduce its advertising campaign? The Nash Equilibrium would be when Optiva and Braun make a profit of $300 million. The conflict is not in the mutual interest of each company, because they make a smaller profit when they both advertise heavily. However, it would be difficult for either company to “demilitarize” because if one company advertises lightly and the other advertises heavily, the second company makes $270 million more than the company that advertised less. Optiva Advertise Light Advertise Heavy Braun Advertise Light ($400, $400) ($250, $520) Advertise Heavy ($520, $250) ($300, $300) 2. Two local companies, Overshoe and Lykarok, sell a similar but not identical cement product. The firms compete in prices and each must set its price for a delivered yard of its own special mix of concrete without knowing what price the other has set. The two firms select one of three prices: either $40, $50, or $60. The resultant quarterly profits (in thousands) are shown for each firm below, with Lykarok’s displayed as the first entry in each pair. Overshoe’s Price: $40 $50 $60 Lykarok’s Price $40 $32, $32 $41, $30 $48, $24 $50 $30, $41 $40, $40 $50, $36 $60 $24, $48 $36, $50 $48, $48 What will be the equilibrium price if the two firms choose their prices simultaneously? If the two firms choose their prices simultaneously, the equilibrium price will be $60 3. Professor Cuthbert Calculus has recently discovered a simple chemical compound which, when ingested daily, will prevent baldness in males. A year’s supply of the pills costs $500 to manufacture. Annual (inverse) demand for the pill in the U.S. is: P = $25,000 – 0.00125 Q ; where Q is measured in units of a year’s supply, i.e., 1
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This note was uploaded on 04/01/2008 for the course EC 0005 taught by Professor Richards during the Spring '08 term at Tufts.

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Ec5p042007-1 - Economics 5 Principles of Microeconomics D...

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