ECON308:ProblemSet3.

2: MonopolisticCompetition

Problem Set 3.2 Monopolistic Competition Frank, 5th Edition: Do 5, 6, Questions for Review, Frank, p. 480 Frank, 4th Edition, Do 5, 6, Questions for Review, Frank, p. 442

Additional Problems: 1. In Balzac there are only two TV stations. At a certain time, each has the choice of broadcasting a hockey game or the Royal Canadian Ballet: 70% of the viewers want to watch the hockey game; 30% want to see the ballet. Each would rather have their fingernails removed than watch the alternative program. If both stations show the same program, they split the audience evenly between them. If maximizing profits means maximizing viewing audience, what programs will the two stations broadcast? In the market equilibrium efficient? Explain your answer.

2. A country consists of two towns, Right and Left. Each has one-third of the population: the remaining one-third lives uniformly scattered on the one straight road that connects the two towns. Everyone is an imbiber. Johnnie Walker and Jack Daniels own the only two liquor licenses. Each drinker will go regularly to whichever bar is closest to him. Unfortunately for Johnnie and Jack, Antie temperance has convinced the powers that if these two gentlemen were unregulated, they would conspire to raise prices; the resulting hardship would be intolerable! Hence, the price of a drink in each bar is equal and determined by the government. The only variable that Jonnie and Jack have control over is their location. a) Find the Nash equilibrium locations of the two drinking establishments. b) If we interpret location as type of product, how would you expect the two drinks to taste vis--vis each other? What does this say about the markets ability to provide a variety of products? c) Are the Nash equilibrium locations likely to be the socially optimal ones? d) Suppose instead that 18 of the population lives in each of the two towns, with the remaining 3 distributed uniformly between the two towns. If there are four taverns, what is the 4 symmetric Nash equilibrium in locations?

3. Consider Hotellings linear city with a length of 1. N consumers are uniformly distributed along the city, where the number of consumers is normalized by 1 (i.e., N = 1). Two firms, Firm 1 and Firm 2, are considering opening new stores in the city. Both firms incur a fixed cost f 3 to open a store, but the marginal cost is zero for both firms. Prices are 8 exogenously fixed at 1. At this price, each consumer buys 1 unit from the nearest store each period.

ECON308:ProblemSet3.2: MonopolisticCompetition

The two firms play a two-stage game. In the first stage, Firm 1 decides how many stores to open and where to locate them. In the second stage Firm 2, having observed the choices by Firm 1, decides whether or not to open a new store. Although the two firms have identical costs, Firm 1 has advantage over Firm 2 as to the number of stores it can open in the first stage. It is assumed that the fixed cost is location specific - if either firm wishes to relocate the store, it must incur the fixed cost fagain. (Hint: Store is profit can be written as: i S i f , where Si is store is market share.) a) Show that if Firm 1 opens only one store in the first stage, then Firm 2 will open a new store in the second stage. What are the resulting profits of the firms? Show that if Firm 1 opens two stores in the first stage, then it can prevent Firm 2 from opening a new store. What is the resulting profit of Firm 1?

b)