Econ170SQ3FALL07(2)

Econ170SQ3FALL07(2) - Economics 170 E. McDevitt SQ #3...

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Economics 170 E. McDevitt SQ #3 Third-Degree Price Discrimination (continued) 1. Evaluate the following statements: a. “In the case of linear demand curves, and given that the seller sells to both types of demanders both with price discrimination and without price discrimination, then third degree price discrimination reduces the social total.” b. “In the case of non-linear demand curves, and given that the seller sells to both types of demanders both with price discrimination and without price discrimination, then the social total necessarily falls if total output is lower under price discrimination.” Limit pricing 1. Suppose the incumbent and potential entrant both face the same constant marginal cost curve. There are no entry costs. Provide a graphical demonstration that the limit output will be such that the incumbent will earn a zero profit and so accommodation will be the most profitable strategy. 2. Suppose there are economies of scale (a fixed entry cost). On a graph, indicate the limit output and price. On the same graph, indicate the price that would exist if the potential entrant did enter and incumbent continued to produce the limit output. 3.P = 50 – Q , Marginal cost is $10 for both firms. The fixed entry cost is $9. a. Find the residual demand curve for the potential entrant. Now solve for potential entrant’s profit maximizing quantity as a function of the incumbent’s output. b. Find the limit output and price. Find profit for the incumbent. IF the potential entrant did enter, verify that its profit would be zero. c. Suppose the incumbent firm accommodates the potential entrant by playing Stackelberg. Find quantities, price and profits in this case. In this case, is it more profitable to deter entry by setting the limit price or by accommodating entry? d. How would your above answers change if the fixed entry cost was 1? e. A criticism of limit-pricing model is that it assumes, rather than justifies, the incumbent firm can credibly commit to the limit output—that is, it actually will produce this output if the potential entrant enters. Explain this criticism by comparing the profit of incumbent if it carries out its threat (produces the limit Q) with its profit if accommodates. In this case, assume accommodation means Cournot competition. You may use your answer to part (b). f. It might seem that the conclusion we arrived at in part (e) ignores the role of reputational effects of predation. That is, perhaps our conclusion in part (e) can be reversed if we assume that the firm faces more than one rival. So while predation may not be worthwhile if the firm only faces one rival, perhaps it is profitable if the incumbent faces rivals in other markets or those who may appear later in time. So by establishing a reputation for toughness in one market may deter entry in other markets or may deter rivals who appear later in time. Evaluate this claim by discussing the Chain Store Paradox. Assume that the incumbent has established operating units in each of ten markets, perhaps in ten different states.
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This note was uploaded on 05/06/2010 for the course ECON econ 170 taught by Professor Mcdevitt during the Spring '10 term at UCLA.

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Econ170SQ3FALL07(2) - Economics 170 E. McDevitt SQ #3...

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