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Industrial organization

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580 visualizzazioni14 pagineIndustrial organization

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Industrial Organization: Markets and Strategies Paul Belleﬂamme and Martin Peitz

published by Cambridge University Press

Part VI. Theory of competition policy

Exercises

Exercise 1 Industries with cartels

Brieﬂy describe and analyze a case of your choice concerning a price- or quantity-ﬁ xing cartel (please not OPEC). The following questions may be useful to bear in mind: What are the relevant characteristics of the industry? What was the scope of the cartel? How was the cartel enforced? What were the eﬀects of the cartels? How did the competition authority or court argue and what was the decision, if any? [suggested length: 1-2 pages, timesnewroman 12 pt, doublespaced]

Exercise 2 Collusion and pricing

Two (advertising-free) newspapers compete in prices for an inﬁnite number of days. The monopoly proﬁts (per day) in the newspaper market are π ^{M} and the discount rate (per day) is δ . If the newspapers compete in prices, they both earn zero proﬁts in the static Nash equilibrium. Finally, if the ﬁrms set the same price, they split the market equally and earn the same pro ﬁts.

1. The newspapers would like to collude on the monopoly price. Write down the strategies that the newspapers could follow to achieve this outcome. Find the discount rates for which they are able to sustain the monopoly price using these strategies.

2. On Sundays, the newspapers sell a weekly magazine (that can be bought without buying the newspaper). The monopoly (competitive) proﬁts when selling the magazine are also π ^{M} (zero).

3. For which discount rates can the monopoly price be sustained only in the market for magazines? (Write down the equation that characterizes the solution.) Compare the solution found in question 1 and 2 and comment brieﬂy.

4. For which discount rates can the monopoly price be sustained both in the market for newspapers and in the market for magazines? (Write down the equation that characterizes the solution.)

1

Exercise 3 Collusion and pricing II

Consider a homogeneous-product duopoly. The two ﬁ rms in the market are assumed to have constant marginal costs of production equal to c. The two ﬁ rms compete possibly over an inﬁnite time horizon. In each period they simultaneously set price p _{i} , i = 1, 2. After each period the market is closed down with probability 1 − δ . Market demand Q( p) is decreasing, where p = min{p _{1} ,p _{2} }. Suppose, fur- thermore, that the monopoly problem is well deﬁ ned, i.e. there is a solution p ^{M} = arg max _{p} pQ( p ). If ﬁ rms set the same price, they share total demand with weight λ for ﬁrm 1 and 1 − λ for ﬁrm 2. Suppose that λ ∈ [1/2, 1) . Suppose that ﬁrms use trigger strategies and Nash punishment.

1. Suppose that δ = 0. Derive the equilibrium of the game.

2. Suppose that δ > 0 and λ = 1/2 . Derive the condition according to which ﬁrm 1 and ﬁrm 2 do not ﬁ nd it proﬁtable to deviate from the collusive price p ^{M} .

3. Suppose that δ > 0 and λ > 1/2. Derive the condition according according to which p ^{M} is played along the equilibrium path. Show that the condition is the more stringent the higher λ.

4. Show that previous results in (3) also hold for any collusive price p ^{C} ∈ (c, p ^{M} ).

5. Suppose that δ > 0 and λ > 1/2 and that ﬁrm 1 can only adjust its price every τ periods. Derive the condition according to which p ^{M} is played along the equilibrium path. How does the time span τ inﬂuence the condition?

Exercise 4 Parallel pricing and evidence of collusion

A competition policy authority has noticed that the ﬁrms in the Lysine industry consistently charge very similar prices, and the suspicion is that they are colluding. Do you think that parallel pricing is proof of collusion? If not, what kind of evidence would you look for?

Exercise 5 Collusion and quantity competition

Consider the following market: Two ﬁrms compete in quantities, i.e., they are Cournot competitors. The ﬁrms produce at constant marginal costs equal to 20. The inverse demand curve in the market is given by P ( q ) = 260 − q .

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1. Find the equilibrium quantities under Cournot competition as well as the quantity that a monopolist would produce. Calculate the equilibrium prof- its in Cournot duopoly and the monopoly proﬁts. Suppose that the ﬁrms compete in this market for an inﬁnite number of periods. The discount factor (per period) is δ , δ ∈ (0, 1).

2. The ﬁ rms would like to collude in order to restrict the total quantity produced to the monopoly quantity. Write down strategies that the ﬁrms could use to achieve this outcome.

3. For which values of δ is collusion sustainable using the strategies of ques- tion (b)? [Hint: Think carefully about what the optimal deviation is.]

Exercise 6 Cournot mergers: proﬁtability and welfare properties

Consider a homogeneous good duopoly with linear demand P ( q ) = 12 − q , where q is the total industry output, and constant marginal costs c = 3.

1. Suppose that ﬁrms simultaneously set quantities. Determine the equilib- rium (price, quantities, proﬁt, welfare).

2. The ﬁrms consider to merge although their production costs are not af- fected. Determine the solution to this problem. Is such a merger prof- itable? What are the welfare eﬀects of such a merger?

3. Suppose that the merger is eﬃciency enhancing, leading to marginal costs c _{m} < c. What are the welfare e ﬀects of such a merger. Do you possibly have to qualify your answer in (2)?

4. Consider the possibility of ﬁrm entry after the merger (the entrant pro- duces at marginal costs c = 3 and has entry cost e). Suppose ﬁrst that the merger is not eﬃciency-enhancing. Analyze such a market and comment on your result (depending on the entry cost e ). Suppose next that the merger is e ﬃciency-enhancing, i.e. c _{m} < 3. Depending on c _{m} and e, when is a merger proﬁ table? [Hint: Calculate proﬁts for c _{m} = 1/2.]

5. Many countries scrutinize merger and sometimes block them (or impose remedies)? Discuss which factors should make the courts or the competi- tion authority more inclined to block a merger.

Exercise 7 Cournot mergers and synergies.

Consider a homogeneous-product Cournot oligopoly with 4 ﬁrms. Suppose that the inverse demand function is P ( q ) = 64 − q .

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1. Suppose that ﬁrms incur a constant marginal cost c = 4. Characterize the Nash equilibrium of the game in which all ﬁrms simultaneously choose quantity.

2. Suppose that ﬁrms 1 and 2 consider to merge and that there are synergies leading to marginal costs c _{m} < c. Characterize the Nash equilibrium. At which level c _{m} (you may want to give an approximate number) are the two ﬁrms indiﬀerent whether to merge?

3. Is such a merger that just makes the two ﬁrms indiﬀerent between merging and non-merging consumer-welfare increasing?

4. At which level c _{m} would the merger be consumer-welfare neutral?

5. Suppose that instead ﬁrms 1, 2, and 3 consider to merge. The new mar- ginal cost of the merged ﬁrms is c _{n} < c. At which level c _{n} are the three ﬁrms indiﬀerent whether to merge?

6. Compare your ﬁndings in (5) and (2). What can you say about incentives to merge in this case?

Exercise 8 Cournot mergers and demand

Consider the following Cournot merger game. The inverse demand function is of the form

P ( q ) = a−q ^{γ}

where γ > 0 and there are n ﬁrms with constant marginal costs of production

c.

1. Discuss the shape of the inverse demand function depending on γ .

2. Determine the Cournot equilibrium pro ﬁts in this set-up.

3. Determine all n for which a single merger, i.e. going from n to n − 1 ﬁrms, is proﬁtable.

Exercise 9 Burning ships

Hernan Cortéz, the Spanish conqueror (”conquistador”), is said to have burned his ships upon the arrival to Mexico. Why would he do such a thing?

Exercise 10 Quantity commitment

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Up to two ﬁrms are in a market in which quantities are the strategic variable. There are two periods; in the ﬁrst period ﬁrm 1 is a protected monopolist. In each of the two periods t = 1, 2 the inverse demand function P ^{t} is given by P ^{t} ( x ^{t} ) = 20 − x ^{t} . In each period the cost function of ﬁrm i is given by C ( x ^{t} )=9+4x ^{t} . Proﬁts of a ﬁrm are the sum of its proﬁts in each period (no discounting). Firms maximize proﬁts by setting quantities.

t

i

i

i

1. Determine the monopoly solution.

2. Because of technological restrictions ﬁrm 1 has to choose the same quantity in each period ( x _{1} ^{1} = x ^{2} ). Observing x _{1} ^{1} , ﬁrm 2 is considering to enter in period 2. Determine the proﬁt maximizing x _{2} ^{2} given x ^{1}

1

1

.

3. Assume that ﬁrm 2 will enter in period 2. What quantity will ﬁ rm 1 produce? Determine equilibrium prices, quantities, and pro ﬁts.

4. Firm 2 only enters in period 2 if it can make positive proﬁts. Determine the subgame perfect equilibrium of the two-period model.

Exercise 11 Strategic quantity choice

Consider a market with two ﬁrms, A and B . The ﬁ rms produce homogenous goods, compete in quantities, and face a constant marginal cost equal to 1/4. The timing is the following: First, ﬁrm A chooses its quantity q _{A} . Then, after observing q _{A} , ﬁrm B chooses its quantity q _{B} . The price in the market is given by the inverse demand function P ( q )=1 − q , where q = q _{A} + q _{B} .

1. Find the subgame perfect Nash equilibrium.

2. Assume from now that there is an entry cost of e. Firm A is already established in the market, and ﬁrm B is considering whether to establish itself in the market or not. The timing is the following: First, ﬁ rm A chooses its quantity q _{A} . Then, after observing q _{A} , ﬁrm B decides whether to enter the market and, in case of entry, how much to produce.

3. Write down ﬁrm B ’s proﬁt function.

4. Assume for now that e = 1/10. Illustrate ﬁrm A’s proﬁt as a function of q _{A} when the reaction of ﬁ rm B is taken into account.

5. Find the subgame perfect Nash equilibrium for all values of e > 0.

Exercise 12 Taxonomy of entry-related strategies I

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Consider a market with diﬀerentiated products. In the ﬁ rst stage ﬁrm 1 is the incumbent ﬁrm and can invest an amount K _{1} ≥ 0 in reducing its marginal costs, c( K _{1} ) = c−K _{1} /10 . In stage two ﬁrm 2 can decides about entering the market with constant marginal costs of c and entry costs of e . In stage three if entry takes place ﬁrms engage in price competition and face symmetric demand functions given by D _{i} (p _{i} ,p _{j} ) = A − ap _{i} + bp _{j} (A>a>b> 0). If no entry takes place, ﬁrm 1 acts as a monopolist with demand, D _{1} (p _{1} ) = A − ap _{1} .

1. Calculate the best response functions for both ﬁrms. Draw a graph. Argue graphically from now on:

2. Does an increase in K _{1} increase or decrease the proﬁ t of the entering ﬁrm? Does an increase in K _{1} make the incumbent tough or soft?

3. Does a marginal investment K _{1} increase or decrease the proﬁt of the in- cumbent? (Assume that e is su ﬃciently low such that entry takes place for K _{1} close to zero. Moreover, assume A ≤ 10)

4. Use your answer of (2): Is entry deterrence via cost reduction possible in this setting? If your answer is YES, which numbers would you have to compare to decide whether entry deterrence is optimal? If your answer is NO, what do we have change in this model to induce entry deterrence?

5. Use your answer of (3): If entry accommodation is optimal how much should ﬁrm 1 invest in cost reduction?

6. How would you answer to (4) change if we consider a Cournot game in- stead?

7. How would you answer to (5) change if we consider a Cournot game in- stead?

Exercise 13 Taxonomy of entry-related strategies II

Consider the market from the previous exercise again.

1. Use the best-response functions from the previous exercise to calculate equilibrium prices for c _{1} 6= c _{2} in the Nash equilibrium in which ﬁrms set prises.

2. Use your result from (1) to show that p = ( A + ac) /(2a − b) , for i = 1, 2, if c _{1} = c _{2} = c.

∗

i

Now, use again that c _{1} ( K _{1} ) = c− ( K _{1} /10) and c _{2} = c. Set c = 4, a = 2, b = 1, A = 10, and F = 7.95 .

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3. Show that the critical level of K

4. Suppose that investment in cost reduction is restricted to half units, i.e. K _{1} ∈ {0, 0.5, 1, 1.5, }. Will ﬁrm 1 deter entry in a subgame perfect Nash equilibrium? State ﬁrm 1’s optimal business strategy.

5. Reconsider your answer to (4) if ﬁrm 1 as a monopolist faces a demand

1 D to deter entry is below 0.5.

of D _{1} (p _{1} ) = A − ap _{1} + bp _{1} = A− ( a−b) p _{1} .

Exercise 14 Sequential quantity choice and entry

Consider a market for a homogenous good with one incumbent ﬁrm (ﬁ rm 1) and one potential entrant (ﬁrm 2). The interaction between the two ﬁrms evolves in two stages. In stage 1, ﬁ rm 1 chooses its quantity q _{1} . In stage 2, after observing q _{1} , ﬁrm 2 decides whether or not to enter the market. If it enters, it incurs an entry cost e and chooses its own quantity, q _{2} . If ﬁrm 2 does not enter then q _{2} = 0 and ﬁrm 2 does not pay the entry cost e (ﬁ rm 1 then is a monopoly). Assume that the inverse demand for the good is P = a − ( q _{1} + q _{2} ) , and that the cost of production of each ﬁrm i is C (q _{i} ) = q _{i} /2.

1. Compute the range of e for which entry is blockaded. That is, compute ﬁrm 1’s output when it operates as a monopolist, then given this quantity, compute the highest proﬁt that ﬁrm 2 can earn if it decides to enter, and ﬁnally, compute the range of e for which entry is blockaded.

2. Now, suppose that e is suﬃciently low to ensure that entry is not block- aded. Compute the quantities and pro ﬁts of each ﬁrm when entry is accommodated. That is, compute the outputs that will be selected in

a Stackelberg equilibrium and the resulting proﬁts. (Instruction: ﬁrst,

compute ﬁrm 2’s best response function, br _{2} ( q _{1} ). Second, substitute for br _{2} ( q _{1} ) into ﬁrm 1’s proﬁ t function and compute ﬁrm 1’s proﬁt-maximizing quantity q . Third, ﬁnd ﬁrm 2’s best response against q , using ﬁrm 2’s best response function. Finally, given the pair of quantities you found, compute the equilibrium proﬁts).

3. Compute the lowest q _{1} for which entry is deterred. Compute ﬁrm 1’s proﬁts at this output level.

4. Given your answer in (3), show ﬁrm 2’s best response function graphically

in the quantities space (recall that ﬁ rm 2 may wish to stay out of the mar-

ket when q _{1} is relatively high). Show on the same graph the Stackelberg equilibrium you found in Section (3) and the lowest q _{1} for which entry is deterred.

5. Given your answers in (2) and (3), ﬁnd the range of e for which entry

is accommodated, and the range of e for which it is deterred. Explain

in no more than 3 sentences the intuition for the result (i.e., why is it natural to expect that entry is accommodated/deterred when e is relatively low/high).

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1

∗

1

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Exercise 15 Capacity choice and entry

Consider an industry for a homogenous product with a single ﬁ rm ( ﬁrm 1) that can produce at zero cost. The demand function in the industry is given by Q = a − p . Now suppose that a second ﬁrm (ﬁrm 2) considers entry into the industry. Firm 2 can also produce at zero cost. If ﬁ rm 2 enters, ﬁ rms 1 and 2 compete by setting prices. Consumers buy from the ﬁ rm that sets the lowest price. If both ﬁrms charge the same prices, consumers buy from ﬁ rm 1.

1. Solve for the Nash equilibrium if ﬁrm 2 chooses to enter the industry. Would ﬁrm 2 wish to enter if entry required some initial investment?

2. Now suppose that before it enters, ﬁrm 2 can choose a capacity, x _{2} , and a price p _{2} (the capacity x _{2} means that ﬁ rm 2 can produce no more than q _{2} = x _{2} units). Given q _{2} and p _{2} , ﬁ rm 1 chooses its price and then consumers decide who to buy from. Compute the Nash equilibrium in the product market if ﬁrm 1 chooses to ﬁght ﬁrm 2. What is ﬁrm 1’s proﬁt in this case? Show ﬁrm 1’s proﬁt in a graph that has quantity on the horizontal axis and price on the vertical axis. Would ﬁrm 2 choose to produce in that case?

3. Now suppose that ﬁ rm 1 decides to accommodate the entry of ﬁrm 2. Compute the residual demand that ﬁrm 1 faces after ﬁrm 2 sells q _{2} units, and then write the maximization problem of ﬁrm 1 and solve it for p _{1} . What is ﬁrm 1’s proﬁt if it decides to accommodate ﬁrm 2’s entry? Draw ﬁrm 1’s proﬁ t in a graph that has quantity on the horizontal axis and price on the vertical axis. Would ﬁrm 2 wish to enter in this case?

4. Given your answers to (2) and (3), compute for each p _{2} the largest capacity that ﬁrm 2 can choose without inducing ﬁrm 1 to ﬁght it. (Hint: to answer the question you need to solve a quadratic equation. The solution is given by the small root).

5. Show that the capacity you computed in (4) is decreasing with p _{2} . Explain the intuition for your answer. Given your answer, explain how ﬁrm 2 will choose its price. Computing p _{2} is too complicated; you are just asked to explain in words how ﬁrm 2 chooses p _{2} .)

Exercise 16 Investment and incumbency

Consider a diﬀerentiated product market. At the ﬁrst stage ﬁrm 1 is the incumbent ﬁrm and can invest an amount I _{1} ≥ 0 in reducing its marginal costs, c(I _{1} ) = c−I _{1} /10. At stage two ﬁ rm 2 decides whether to enter the market with constant marginal costs of c and entry costs of e , which is sunk at this stage. At stage three, if entry has taken place, ﬁ rms engage in quantity competition and face inverse demand functions given by P _{i} ( q _{i} ,q _{j} ) = a−bq _{i} −dq _{j} ( a>b>d> 0). If no entry takes place, ﬁrm 1 acts as a monopolist with inverse demand, P ^{m} (q _{1} ) = a − bq _{1} .

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1. Calculate the best response functions for both ﬁrms. Draw a graph.

2. Does an increase in I _{1} increase or decrease the proﬁ t of the entering ﬁrm? Does an increase in I _{1} make the incumbent tough or soft?

3. Does a marginal investment I _{1} > 0 increase or decrease the proﬁt of the incumbent? (Assume that e is suﬃciently low such that entry takes place for I _{1} close to zero.)

4. If entry accommodation is optimal how much should ﬁrm 1 invest in cost reduction? (Use your answer of (3).)

5. Is entry deterrence via cost reduction possible and proﬁtable in this set- ting? Discuss your results in the light of the taxonomy developed in the book.

Exercise 17 Competition and entry

Consider a homogeneous good duopoly with linear demand P ( q )=1 − q , where q is the total industry output. Suppose that ﬁrms are quantity setters and ﬁrms incur constant marginal costs of production c _{i} .

1. Suppose that ﬁrms have constant marginal costs of production c. Deter- mine the Nash equilibrium in quantities (report prices, quantities, pro ﬁt, welfare)

2. Reconsider your answer in (1) because of the following: A tabloid runs a series on consumers paying “excessive” prices. The government considers introducing a non-negative special sales tax t ≥ 0 per unit on this prod- uct (and plans to use the revenues for some project from which nobody beneﬁts). Determine the welfare-maximizing tax rate (the government is assumed to be able to commit to the tax; welfare is total surplus which in- cludes tax revenues). Discuss your result. What would be your conclusion if the government was considering subsidizing the ﬁrm?

3. Return to the case without taxes. Consider now the duopoly with c _{1} = 0 and c _{2} = c ∈ [0, 1] . Determine the equilibrium (price, quantities, proﬁt, welfare).

4. Consider now an extended model in which only ﬁrm 1 is necessarily present. At stage 1, ﬁ rm 1 can make an investment I after which ﬁ rm 2’s marginal costs is c _{2} = 1/2 instead of c _{2} = 0. Afterwards, ﬁrm 2 ob- serves the investment decision of ﬁrm 1 and, at stage 2, decides whether to enter at a negligible entry cost e > 0. At stage 3, active ﬁrms set quantities simultaneously. Determine the subgame perfect equilibrium of this game. Discuss your result in the light of what you have learnt reading about entry-related strategies (max 3 sentences).

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5. Consider now a diﬀerent entry model. Both ﬁrms have zero marginal costs of production but consumers have become accustomed to product 1 (even if they did not consume it themselves). Therefore, consumers are willing to pay 1/2 money units less for product 2 than for product 1. The inverse demand function P ( q )=1 − q gives demand for product 1. At stage 1, the potential entrant, ﬁ rm 2, considers to enter the market at an entry cost e > 0. (There is no investment stage in this game.) At stage 2, ﬁrms set quantities simultaneously. Report the proﬁ t function for each ﬁrm. Determine the equilibrium in case ﬁrm 2 has entered (report prices, quantities, proﬁt, welfare). Determine the subgame perfect equilibrium and comment on your result. You may want to reuse some of the results derived above.

Exercise 18 Non-linear pricing in the supply chain

A monopolist produces a good with constant marginal cost equal to c, c < 1. Assume for now that all consumers have the demand Q(p )=1 − p . The population is of size 1.

1. Suppose that the monopolist cannot discriminate in any way among the consumers and has to charge a uniform price, p ^{U} . Calculate both the price that maximizes proﬁ ts and the proﬁts that correspond to this price.

2. Suppose now that the monopolist can charge a two-part tari ﬀ (m, p) where m is the ﬁxed fee and p is the price per unit. Expenditure then is m + pq . Calculate the two-part tariﬀ that maximizes proﬁts and the proﬁts that correspond to this tari ﬀ. Compare p ^{U} and p and comment brieﬂ y.

3. Compare the situation with a uniform price and a two-part tari ﬀ in terms of welfare (a verbal argument is su ﬃcient).

4. Assume now instead that there are two types of consumers. The consumers of type 1 have the demand Q _{1} ( p)=1 − p, and the consumers of type 2 have the demand Q _{2} (p )=1 − p/2. The population is of size 1 and there are equally many consumers of the two types. Finally, it is assumed in this question that c = 1/2. Calculate the two-part tari ﬀ that maximizes the proﬁts of the monopolist. Compare the two-part tari ﬀs found in questions (2) and (3) for c = 1/2 and comment brieﬂy.

Exercise 19 RPM

RPM was common in a number of industries. In particular, it could be observed in the clothing, consumer elec tronics, and food industry. What is the probable motivation for ﬁ rms to use RPM in these industries. Discuss the likely welfare consequences in these industries.

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Exercise 20 Vertical contracting

A buyer wants to buy one unit of a good from an incumbent seller. The buyer’s valuation of the good is 1, while the seller’s cost of producing it is 1/2. Before the parties trade, a rival seller enters the market and his cost, c, is distributed on the unit interval according to a distribution function with density g (c) . The two sellers then simultaneously make price oﬀers and the buyer trades with the seller who oﬀers the lowest price. If the two sellers o ﬀer the same price the buyer buys from the seller whose cost is lower.

1. Determine the price that the buyer pays in equilibrium, p ^{∗} , as a function of c. Given p ^{∗} , write the payoﬀs of the expected payoﬀs of the buyer and the two sellers.

2. Suppose that the distribution of c is uniform. Show p ^{∗} and the expected payoﬀs of the parties graphically (put c on the horizontal axis and the equilibrium price function on the vertical axis and show the payo ﬀs by pointing out the appropriate areas in the graph).

3. Now suppose that the incumbent seller o ﬀers the buyer a contract before the entrant shows up. The contract requires the buyer to pay the incum- bent seller the amount m regardless of whether he buys from him or from the entrant, and gives the buyer an option to buy from the incumbent at a price of p (this is equivalent to giving the buyer an option to buy at a price m + p and requiring him to pay liquidated damages of m if he switches to the entrant). If the buyer rejects the contract things are as in part (1). Given p and c, what is the price that the buyer will end up paying for the good? Using your answer, write the expected payo ﬀs of the buyer and the two sellers as a function of p and m.

4. Explain why the incumbent seller will choose p by maximizing the sum of his expected payoﬀ, π _{I} , and the buyer’s expected payoﬀs, U _{B} .

5. Write the ﬁrst-order condition for p and show that the proﬁt-maximizing price of the incumbent seller, p ^{∗}^{∗} , is such that p ^{∗}^{∗} < 1/2. Also show that if g (0) > 0 then p ^{∗}^{∗} > 0.

6. Explain why the contract is socially ineﬃcient. Is the outcome in part (1) socially e ﬃcient? Explain the intuition for your answer.

7. Compute p ^{∗}^{∗} assuming that the distribution of c is uniform, and show the expected payoﬀs of the parties and the socia l loss graphically (again, put c on the horizontal axis and the equilibrium price function on the vertical axis).

8. Compute p ^{∗}^{∗} under the assumption that G( c) = c ^{α} , where α > 0. How does p ^{∗}^{∗} vary with α ? Give an intuition for this result.

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Exercise 21 Franchising

A monopolistic manufacturer produces a good that is sold to three retailers.

The manufacturer has constant marginal cost equal to c <

monopolists in three diﬀerent cities. The marginal cost of the retailers is equal to the wholesale price of the good. Each of the retailers faces a demand function Q _{b} = 1 − b p where p is the retail and b is a variable characterizing the local demand function. Each retailer knows the value of b in its city. Furthermore, it is common knowledge that b = 1 in one city and b = z in two cities, z ∈ (1, 2]. The manufacturer oﬀers each of the retailers a two-part tariﬀ consisting of a wholesale price w and a franchise fee f . Let us assume that the retailers accept any contract that results in nonnegative pro ﬁts. The retailers choose the retail price p in their market (i.e., there is no resale price maintenance).

_{2} 1 and take f as given. Find the price that a retailer sets as a

function of b. Who earns the highest pro ﬁt, retailers with b = 1 or b = z ?

_{2} 1 . The retailers are

1. Let w <

2. Assume in the rest of the exercise that z = 2. Suppose ﬁ rst that the manufacturer knows the value of b in all three cities and that z = 2. What contract will the manufacturer oﬀer to the retailers? Is the franchise fee the same for all retailers? Is it possible for the retailer to extract all pro ﬁts in the vertical chain? Assume from now on that the manufacturer does not know the retailers’ individual b . However, the manufacturer knows that two of the retailers have b = z = 2 and that one retailer has b = 1. Assume also that the manufacturer wishes to serve all retailers.

3. Find the optimal franchise fee as a function of the wholesale price w .

4. Find the optimal wholesale price as a function of c. Is the wholesale price greater or less than c?

5. Can the manufacturer extract all proﬁts by setting w and f optimally?

6. Assume now instead that c = 1/4. Show that it is optimal for the manu- facturer only to sell to the retailer with b = 1. What happens if c → 0?

Exercise 22 Exclusive dealing

Suppose that two ﬁrms produce at constant marginal costs c. There are two periods and m buyers. Each buyer has an inverse demand curve: P ( q _{I} + q _{E} ) = 1 − ( q _{I} + q _{E} ) where q _{I} is the quantity sold by the incumbent and q _{E} is the quantity sold by the entrant. In the ﬁrst period, there is only the incumbent in the market. Thus, the incumbent produces the monopoly quantity. The incumbent has marginal cost equal to c _{I} . In the second period, an entrant with constant marginal cost equal to zero enters into the market. The entry is foreseen by the buyers. After entry, the two ﬁ rms compete à la Cournot. In the ﬁ rst period, the incumbent oﬀers the buyers a fee for an exclusive dealing agreement (take-it-or-leave-it). If a buyer accepts the oﬀer, she cannot buy from the entrant in the second period.

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1. Suppose that the incumbent and entrant are equally eﬃcient, i.e. c _{I} = 0. What is the maximal fee for an exclusive dealing agreement that the incumbent is willing to oﬀer to a buyer? What is the minimum fee that a buyer is willing to accept for signing an exclusive dealing agreement? Will there be exclusive dealing in equilibrium?

2. Consider a general marginal cost of the incumbent c _{I} . For which values of c _{I} will exclusive dealing arise in equilibrium?

Exercise 23 Long-term contracts, upgrades, and exclusion

Consider a market for a base good that is sold over two periods. In period 2, also an upgrade may become available. For simplicity, set the mass of consumers equal to 1 and marginal costs equal to zero. Firm 1 can be active in periods

1 and 2, ﬁrm 2 can only be active in period 2. At the beginning of period 2,

ﬁ rms decide simultaneously whether to upgrade. Suppose that ﬁ rms maximize the sum of proﬁts in periods 1 and 2. The willingness-to-pay without upgrades is V per consumer in each period. An upgrade by ﬁrm 1 leads to a surplus of r + λ _{1} , while an upgrade by ﬁ rm

2 would lead to a surplus of r + λ _{2} . Firm 2 is assumed to be more eﬃcient, λ _{2} >λ _{1} . The upgrading cost is C . Suppose furthermore that λ _{1} > C . This assumption means that upgrading is socially superior to not upgrading even if it is done by the less eﬃcient ﬁrm.

1. Characterize the equilibrium if ﬁ rms can only oﬀer short-term contracts, i.e., ﬁrm 1, when selling to consumers in period 1, cannot make them sign a contract that binds consumers to buy from it in period 2.

2. Characterize the equilibrium if ﬁrm 1 can oﬀer a long-term contract that does not allow consumers or prevents them from buying from ﬁ rm 2. Dis- cuss your result.

Exercise 24 Vertical duopoly and vertical integration.

Consider a vertical duopoly with exclusive dealing contracts in place, i.e., upstream ﬁrm i only sells to downstream ﬁrm ´ı , i = 1, 2. Suppose that, at stage 1, upstream ﬁ rms and then, at stage 2, downstream ﬁrms set prices. Downstream demand is of the form Q _{i} ( p _{i} ,p _{j} )=1 − bp _{i} + dp _{j} . Upstream ﬁrms have zero marginal costs of production and set their wholesale price. Consider subgame perfect equilibria.

1. Characterize equilibrium upstream and downstream prices.

2. Suppose that b = d = 1. Characterize the equilibrium if ﬁ rms indexed by 1 have vertically integrated (so that the integrated ﬁrm’s transfer price is

0).

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3. Are there incentives for vertical integration (for b = d = 1)? Discuss your results.

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