Unformatted text preview: Econ 425‐100 Spring 2011 Instructor Fan Ji Homework 1 (50 Points Total) Name_______________ Due on Feb 11th, 2011 Part One (18 points) : Multiple Choice (3 points each) Choose the one alternative that best completes the statement or answers the question. 1. Internet service in the local market is supplied by Laura's Internet Service. Laura has two types of consumers: local businesses and residential customers. Local businesses have a demand function given by Qb = 8,500 – 100p, while residential customers have a demand function given by Qr = 12,500 – 500p. What can we say about Laura’s behavior if she follows a third‐degree price discrimination strategy and charges business customers pb = $35 and residential customers pr = $15? a. Laura is maximizing profits since pb/pr = 7/3 is the optimal price ratio. b. Laura is not maximizing profits since the price ratio should be equal to 7. c. Laura is not maximizing profits since the price ratio should be equal to 9/3. d. We don’ know if Laura is maximizing profits since we don’ know her cost function. t t e. Laura may or may not be maximizing profits depending on the amount of her fixed costs. 2. The Walt Disney Corporation ran several special promotions on tickets to Disneyland. Residents of Orlando, for example, are offered admission at the special price of $40. Other visitors to Disneyland are usually charged about $70. This practice is an example of: a. First‐degree price discrimination. b. Second‐degree price discrimination. c. Third‐degree price discrimination. d. Intertemporal price discrimination. e. None of the above. 3. Consider the following extensive‐form representation of a game where the incumbent, under the threat of entry, may expand output in the first period to reduce costs in the second period from learning by doing: The subgame‐perfect equilibrium of this game is: a. Incumbent increases output (high output) in period 1 and potential entrant will enter in period 2. b. Incumbent increases output (high output) in period 1 and potential entrant will not enter in period 2. c. Incumbent does not increase output (low output) in period 1 and potential entrant will enter in period 2. d. Incumbent does not increase output (low output) in period 1 and potential entrant will not enter in period 2. 4. Refer to the following two statements to answer this question: I. Both consumers and firms are worse off with successfully monopolies upstream and downstream than when there is a single, integrated monopoly. II. One advantage of franchisee agreements over vertical integration is that a franchisee usually keeps most of his profits, so he has more incentives to work harder than a salaried employee of the franchisor would. a. Both I and II are true. b. I is false, and II is true. c. Both I and II are false. d. I is true, and II is false. 5. Your reservation price for trout (T) is $20 and your reservation price for a lemon pie (L) is $6. If you attend a restaurant where you may order each dish à la carte, at $16 each, or you may order them together as a complete meal (i.e. as a bundle) at $24, you will: a. Only order lemon pie. b. Only order trout. c. Order the complete meal. d. Not order anything. 6. A national chain of bookstores has initiated a frequent buyer program. If you buy a frequent buyer card for $10, you are entitled to a 10 percent discount on all purchases for 1 year. This practice is an example of: a. Intertemporal price discrimination. b. Third‐degree price discrimination. c. Quantity discount. d. Two‐part tariff. e. Both (c) and (d) are valid. Part Two: Short Questions (32 Points) Be clear about your answer and use GRAPH when necessary 1. Some restaurants offer free meals for children accompanied by adults. Rather than a form of price discrimination, this is a promotional strategy frequently practiced by restaurants. Comment true or false and state your reasoning. (4 points) 2. A couple of years ago Coca‐Cola announced that they were developing a “smart” vending machine, i.e. machines that are able to change prices according to outside temperature (Financial Times, 1999). Suppose for the purpose of this problem that the temperature can be either “high” or “low”. On days of “high” temperature, demand is given by Q = 280 – 2p, where Q is number of cans of Coke sold during the day and p is the price per can measured in cents. On days of “low” temperature, demand is only Q = 160 – 2p. The marginal cost of a can of Coke is 20 cents. (14 points) a. Suppose that Coca‐Cola indeed installed “smart” vending machines, and thus is able to charge different prices for Coke on “hot” and “cold” days. What price should Coca‐Cola charge on a “hot” day and on a “cold” day? b. Alternatively, suppose that Coca‐Cola just continued to use its normal vending machines, which, as we all know, must be programmed with a fixed price independent of the weather. What is the optimal price for a can of Coke in this case? c. What are Coca‐Cola’s profits under weather‐variable and constant prices? Now suppose that in the near future, Coca‐Cola develops an even “smarter” vending machine that is able to figure out the reservation price of each consumer and extract all surplus from each individual. d. What would be the lowest price that Coca‐Cola would charge and how many cans would it sell? What profit would Coca‐Cola make under this pricing strategy? 3. Firm 1 is an incumbent in a market lasting two periods with inverse demand curve p = 74 – 9Q. Its first‐period costs are C = 15 + 20q and it faces entry in the second period by Firm 2, which has identical costs. However, there is an asymmetry between the firms in that only Firm 1 has the option of investing $63.5 in R&D in the first period in order to reduce its second‐period marginal costs to $2 per unit. (14 points) a. Derive the extensive‐form representation of this R&D game that shows the sequence of all possible actions and outcomes (profits) for both firms. Assume that entry would result in a Cournot duopoly. b. Show that it is optimal for Firm 1 to make this investment even though Firm 2 enters regardless. c. Also show that it would not be optimal for Firm 1 to make the investment if there were no threat of entry. ...
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This note was uploaded on 05/01/2011 for the course ECON 425 taught by Professor Watugala during the Spring '06 term at Texas A&M.
- Spring '06