03 Jun Question ECON 480: Industrial Competition and Monopoly
Question
ECON 480: Industrial Competition and Monopoly
Practice problems: Final Exam
1 Market foreclosure
1. (Vertical Mergers) Consider the market for solar-powered vehicles served by two firms
(A and B). The demand for these vehicles is given by Q = 2 ? P. Firm S is a monopolist
in the market for solar panels. Firm S produces solar panels at MC = 0 and sells solar
panels to both Firm A and Firm B at price w. Firm A and Firm B convert one solar panel
into the final good, which is sold at price P. Assume that Firm A and B cannot affect Firm
S’s choice of w. Assume that Firm A and Firm B play a quantity competition game.
a) Find the equilibrium of the market for solar-powered vehicles. Note: The solution
will depend on w.
b) Find Firm S’s optimal price for solar panels, w.
c) Assume now that Firm S and Firm A merge. Assume that Firm S transfers solar
panels to Firm A at no cost (wA = 0). Find the optimal price at which the merged
firm sells solar panels to Firm B, wB.
d) Is market foreclosure achieved as a consequence of the vertical merger?
e) Why does the merger increase welfare? Explain.
2. (Bundling) Consider the market for web browsers. Assume that there are two firms selling
web browsers (homogeneous product): Microshot (M) and Escape (E). There is one
firm selling a word processor: Microshot (M). Assume that N = 1000 consumers populate
this market and that firms compete in prices. Consumers value owning the word
processor in VP = 3 and value owing the web browser in VWB = 2. Microshot produces a
unit of the web browser at MCWB,M = 1 and a unit of the word processor at MCP,M = 0.
Escape produces a unit of the web browser at MCWB,E = 0. There is a fixed cost of operation
F = 100 that any active firm must pay.
Assume that Microshot moves first and announces whether it will bundle the word processor
and the web browser. Escape moves second and decides whether to exit the mar-
1ket.
a) Use backward induction to find the equilibrium of the game.
b) Does the equilibrium involve market foreclosure?
c) How does welfare change in equilibrium if bundling was prohibited?
2 Innovation
3. (Intellectual Property and the Incentives to Innovate) Consider the market for a homogeneous
product. The demand for this product is given by Q = 1 ? P. There are two firms
serving this market: Firm A and Firm B. Both firms produce at a constant marginal cost c,
with c < 1/2. Firm A, however, has a project that would reduce its marginal cost to zero. Undertaking this project would cost I dollars. Assume that Firm A and Firm B compete in prices. a) Assume that there is a law that would prevent Firm B from copying Firm A’s innovation. For what values of I would Firm A invest in the project? b) Assume that there is a law that would only partially protect Firm A’s invention. That is, if Firm A’s innovates, Firm A’s marginal cost drops to zero and Firm B’s marginal cost drops to c/2. For what values of I would Firm A invest in the project? c) How does intellectual property protection affect the incentives to innovate? 4. (Competition and the Incentives to Innovate) Consider the market for a homogeneous product. The demand for this product is given by Q = 1 ? P. Consider the existence of N serving this market. All firms produce at a constant marginal cost c, with c < 1/2. Firm A, however, has a project that would reduce its marginal cost to zero. Undertaking this project would cost I dollars. Assume that the N firms compete in prices. Assume that there is a law that would prevent any firm from copying Firm A’s innovation. a) Assume that N = 1, that is, that Firm A is a monopolist. How much does Firm A gain when implementing the project? b) Assume that N = 2, that is, that Firm A faces the competition of Firm B. How much does Firm A gain when implementing the project? 2c) How does competition affect the incentives to innovate? 5. (Patent Length and the Incentives to Innovate) Consider the market for a homogeneous product. The demand for this product is given by Q = a ? P. There are two firms serving this market: Firm A and Firm B. Both firms produce at a constant marginal cost c, with c < 1/2. Firm A, however, has a project that would reduce its marginal cost to c ? x, where x is chosen by the firm. Undertaking this project would cost x 2/2 dollars. A patent would protect Firm A’s invention for T periods (that is, after the expiration of the patent, Firm B can copy Firm A’s technology). Assume that Firm A and Firm B compete in prices. Assume that the discount rate is ?. a) Find Firm A’s optimal level of investment as a function of the patent length, T. b) How much does Firm A invest when T = 0? Use your answer to part a). c) How does Firm A’s investment change with an increase in patent length, T? Use your answer to part a). 3
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