Economics 170
E. McDevitt
SQ #3
ThirdDegree 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 nonlinear 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 limitpricing 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.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '10
 McDevitt
 Pricing, Price Discrimination, Stackelberg, potential entrant

Click to edit the document details