MDI Gurgaon

PGPM End Term-2016

Microeconomics
Section D
Marks 30 Time 2 hours
N.B. Closed book
Answer the first question compulsorily and only 1 question from remaining. Extra question
attempted would not be evaluated.

1. Read the following case study and answer the following: 5+5+3+3+4=20
Pricing of the internet- the Great Net Neutrality Debate (Ref: Salvatore & Rastogi,
Managerial Economics, Chap 12, Oxford, 8ed)
Chances are that most people have already formed an opinion about net neutrality before
beginning to read this case study. However the issue of pricing data bandwidth for Internet
usage is so complicated that most experts have a layered opinion; although, often, people
with incomplete understanding of the issue are cocksure of their opinion.
When one talks about the net neutrality, it essentially means that Internet Service Provider
(ISP) must charge the same price for all bits of data, irrespective of the usage. The ISP does
not like this position because video streaming websites cost them a dedicated server and
therefore more cost. Similarly, voice or video calls over the internet also hurt their business
through more server cost as well as diversion of traffic away from their telecom business.
The activists, on the other hand, argue that leaving the pricing of data to the discretion of
ISP will eventually lead to manipulation of information choices. For example, Airtel India
tried launching a non-net neutral Internet package, wherein only Flipkart was freely
available but competitors were shutoff. Similarly, Facebook tried launching Free Basics with
free Facebook and Wikipedia but highly priced Google services. The pricing mechanism
would divert traffic to particular sellers, utilities and information providers. So how do we
decide the best way to safeguard the consumers, while making sure the businesses also
survive and make a reasonable profit?
Well the answer to the above is Platform Economics where you charge differential pricing.
However the debate is not so much about differential pricing on two sides of platform, but
strategic decisions by the platform owner (the telecom companies that are gatekeepers to
the Internet) to offer differential access to different players on the same side of the market.
This can be either done using prices or privileged access or both. There are several nuanced
issues here. Economists have not been able to agree on whether moving away from the
principles of Net neutrality is welcome or not.
One key issue for regulators is whether moving away from Net neutrality increases or
reduces social welfare. One of the most comprehensive reviews on the Economics of Net
Neutrality, Florian Schuett of Tilbrug University provides a succinct rule: “The crucial
condition for a zero-price rule to be welfare enhancing is that consumers value additional
content providers more highly than content providers value additional consumers.”
a. Why is there no consensus among economists about net neutrality? What are the differing
opinions?
b. What is the economics of two-sided markets? Apart from digital economy does it apply to
any other markets?
c. Is the market for Internet competitive, oligopolistic, monopolistic or monopoly market?
d. What type of pricing strategy is referred here? Analyze in details
e. Why the article says zero-price is welfare enhancing only when “consumers value additional
content providers more highly than content providers value additional consumers”. Do you
agree? Give reasons

2. This question has four parts: 3+2+2+3=10

a. How does adverse selection problem lead to market failure?
b. What are the two different ways adopted to tackle such problems?
c. In this example below is there any such adverse selection problem? Explain.

Type % Risk Cost to Willing to

Insure
Of Illness Pay

Healthy 50 1/1000 90 140

Sick 50 1/500 220 250

d. How should a manager in Insurance company design its premium charged on two different
categories of sick and healthy people in the above example with some additional
information as follows: Cost of physical exam for healthy person is Rs 40 and that of sick person is
Rs 160.

3. This question has two parts: 5+5=10

a. Show that in monopolistically competitive firm there is absence of economic efficiency and
presence of excess capacity. Also show that extent of excess capacity is inversely related to
elasticity of demand faced by a firm.
b. Jio Telecomm is launching their services with low prices on various services as compared
with the incumbents in the industry. What sort of pricing strategy is referred here? What do
you think will the reaction of the incumbents to entrant’s strategy