Problem Set 4 Microeconomic Theory: A Mathematical Approach (Monopoly, Game Theory1 ) 1. Price Discrimination.

There is one product provided by a rm. There are two consumers each of whom demands at most two units of the product. Consumers are characterised by their marginal valuations vi1 and vi2 , where vij is consumer is marginal valuation for jth unit of the product. That is, if consumer i consumes one unit of the good, her valuation is vi1 and if she consumes two units, her valuation is vi1 + vi2 . Consumers make the choice that maximizes the dierence between their valuation and the price they pay for it. Assume that rm can costlessly provide any amount of the product. Let v11 = 5, v12 = 3, v21 = 6 and v22 = 1. Solve the rms prot maximization problem in each of the following cases: (a) Firm is a rst-degree price discriminating monopolist. (b) Firm is a second-degree price discriminating monopolist. (c) Firm is a third-degree price discrminating monopolist. (d) Firm is a non-discriminating monopolist. (e) Firm is competitive. 2. Multi-plant Monopolist. Consider a multi-plant monopolist with two production units. (a) The cost function of the i-th plant is 1 + qi , if qi > 0 and zero otherwise. Let the demand function facing the monopolist be q = max{10 p, 0}. Solve for the optimal monopoly outcome. (b) How would your answer change if the cost function of the i-th plant is 1 + qi , qi 0? Explain.
2 (c) How would your answer change if the cost function of the i-th plant is 1 + qi , if qi > 0 and zero otherwise? Explain.

3. Monopolist problem: A Variant. There are 20 buyers with low demand price function p1 (q1 ) = 20 2q1 and 10 with high demand price function p2 (q2 ) = 40 2q2 . The monopoly seller has q units available. (a) Write down the monopolists optimization problem. (b) If the seller has q = 240 units available, are either of the following output vectors optimal? (q1 , q2 ) = (3, 18), (q1 , q2 ) = (4, 16) (c) For what values of q will the monopolist sell only to the 10 high demanders? 4. Vertically-related Firms. Consider two vertically related rms, A and B. Each is a monopolist. A produces good F which is used by B as input in his own production of good X. Bs production function is given by X = f (F ) = F . The demand function for X is given by p(X) = a bX. The marginal cost of monopolist A is constant and given by v. Monopolist B incurs a cost of c per unit produced in addition to the cost of the input from A. Show that the nal output levels when the rms are integrated are twice the output levels when they are not integrated.
1 Ref:

An Introduction to Game Theory by Osborne, Contact: econschool@gmail.com

5. Third-degree price discrimination. In market 1 we have Qd (p) = 10p/2 while in market 2 we have Qd (p) = 322p. The monopolists total cost function is TC(y) = y 2 . What outputs does the thirddegree price discriminating monopolist sell in each market? What if monopolist is not allowed to discriminate and has to sell the commodity at uniform price in both markets? What if monopolist is a rst-degree price discriminating monopolist? What if monopolist acts as a competitive rm. Compare the quantity sold and prots in the four cases. Also check for the welfare (Welfare = Consumer surplus + Producer surplus). Which of the outcomes is pareto ecient? 6. Second-Degree Price Discrimination. A monopolist faces two consumers, one with demand function DH (P ) = 12 bH P and the other with demand function DL (P ) = 12 bL P , where 0 < bH < bL < 2bH . The monopolist cannot tell which consumer has the higher demand and which has the lower demand, although he knows the two demand functions. The monopolist decides to sell the good in bundles or packages. Denote a package as a pair (Q, V ) where Q is the number of units of the product and V is the price of the entire package (not the price per unit). He considers three options. Option 1: sell only one package, targeted to the consumer with high demand. Option 2: sell two identical packages, designed in such a way that each consumer will buy one package. Option 3: sell two dierent packages, one targeted to the high-demand consumer and the other to the low-demand consumer. The monopolist has the following cost function: C(Q) = Q (a) Determine the prot maximizing package for option 1 and calculate the corresponding prots. (b) Determine the prot maximizing package for option 2 and calculate the corresponding prots. (c) For option 3 write the constraints that must be satised in order for each consumer to end up buying the package which is designed for her. (d) Determine the prot maximizing package for option 3. (e) Now assume that bH = 2 and bL = 3. Rank the three options based on the prots they yield. Calculate total surplus with the best (in terms of prot-maximization) of the three options. Calculate also the eective price(s) per unit. What would the monopolists prots be if he were able to use the rst-degree price discrimination? 7. Cournot Game. Consider a market in which there are three rms, each producing the same good. Firm is cost of producing qi units of the good is Ci (qi ) = 16 for qi > 0 and Ci (0) = 0 for each i {1, 2, 3}; the price at which output is sold when the total output is Q is P d (Q) = max{20Q, 0}, where Q = q1 + q2 + q3 . Each rms strategic variable is output and the rms make their decisions simultaneously. Find the Nash equilibria of Cournots oligopoly game. 8. Monopolistic Competition. Consider a monopolistically competitive industry in long-run equilibrium. Each rm in the industry has the total cost function C = 10q + 100 where q is the rms output level. Each rm faces the linear inverse demand function p = 200 q 0.5q where p is the rms price and q is the total output produced by all other rms in the industry. Solve for the long-run equilibrium levels of output produced by each rm, the price charged by each rm, and the total number of rms in the industry assuming that rms play Cournot-Nash on output. Include a diagram showing the rms long-run equilibrium price, average cost, and output level. 9. Bertrand Game. A single good is produced by two rms; each rm can produce qi units of the good at a cost of Ci (qi ) = 2qi . Each rm chooses a price, and produces enough output to meet the demand it faces, given the price chosen by the other rm. If the good is available at the price p then the total amount demanded is D(p) = max{10 p, 0}. Assume that if the rms set dierent prices then all consumers purchase the good from the rm with the lowest price, which produces enough output to meet this demand. If both the rms sets the same price then they share the demand at that price equally. A rm whose price is not the lowest price receives no demand and produces no output. (Note that a rm does not choose its output strategically; it simply produces

enough to satisfy all the demand it faces, given the prices, even if its price is below its unit cost, in which case it makes a loss. Bertrands oligopoly game is the following strategic game. Players The rms. Actions Each rms set of actions is the set of possible prices (nonnegative numbers). Preferences Firm is preferences are represented by its prot, equal to pi D(pi )/mCi (D(pi )/m) if rm i is one of m rms setting the lowest price (m = 1 if rm is price pi is lower than every other price), and equal to zero if some rms price is lower than pi . (a) Find the best response correspondences of the two rms. (b) Find a Nash equilibrium. 10. Bertrand Game with integer prices. Consider Bertrands duopoly game where there are n = 2 rms, the cost functions are Ci (qi ) = cqi for i {1, 2}, and the demand function is D(p) = max{0, p}. Restrict each rm to choose an integral price (e.g., representing an integral number of rupees). Assume that c is an integer and also assume that > c + 1 and c > 0 so that positive prot is possible. Find the set of all Nash equilibria. 11. Third-price auction. Consider a third-price sealed-bid auction, which diers from a rst- and a second-price auction only in that the winner (the person who submits the highest bid) pays the third highest price. Assume that there are three bidders. Assume that the bidders valuations of the object are all dierent and all positive; number the players 1 through 3 in such a way that v1 > v2 > v3 > 0. (a) Show that the action prole in which each player bids her valuation is not a Nash equilibrium. (b) Find a Nash equilibrium. 12. Joint venture. Two high tech rms (1 and 2) are considering a joint venture. Each rm i can invest in a novel technology, and can choose a level of investment xi from 0 to 5 at a cost of x2 i 4 (think of x as how many hours to train employees, or how much capital to buy for R&D labs). The revenue of each rm depends both on its investment, and of the other rms investment. In particular, if rm i and j choose xi and xj respectively, then the gross revenue to rm i is 0, if xi < 1 R(xi , xj ) = 2, if xi 1 and xj < 2 xi xj , if xi 1 and xj 2 ci (xi ) = (a) What is the best response function of rm i? (b) Find a Nash equilibrium. 13. Public Goods. An economy has n consumers. Each consumer belongs to one of the two possible types, type 1 and type 2. Consumers have preferences over a private good x, and a non-excludable public good G. The utility of a representative agent of type i is ui (x, G) = ln x + i ln G with 1 = 1, 2 [0, 1). Type 1 and 2 consumers respectively have an endowment of 1 unit and 0.5 units of the private good. Each consumer j contributes an amount gj from his endowment for the production of the public good. One unit of the private good can be costlessly transformed into one unit of the public good, and vice versa. Hence the amount of public good produced is given
n

by G =
j=1

gj .

In a symmetric Nash equilibrium in which all consumers of the same type contribute the same amount for the public good, what will be the total production of the public good?