Question Problem Set 4 Economics 121

04 Jun Question Problem Set 4 Economics 121

Question

Problem Set 4

Economics 121

Problem Set 4

Economics 121

Industrial Organization and Public Policy

Please write your name, student ID and GSI’s name on the top of your problem set.

1) Suppose Comcast sells three cable channels A, B, and C. All customers are the same

and their valuations are given by VA=VB=VC=6, VAB=VAC=VBC=10, and VABC=13.

Assume that the cost of providing the channels is 0.

a) Are the channels perfect substitutes, imperfect substitutes, or complements for

each other? Explain.

b) What price will Comcast charge if it pursues pure bundling, selling a bundle of A,

B, C.

c) Suppose Comcast is required to sell the channels separately and not allowed to

sell with a package discount. What prices will Comcast charge and what will be

its revenue per customer if it wants customers to buy all the channels? What

prices will Comcast charge and what will be its revenue per customer if it wants

customers to buy only channels A&B? What prices will Comcast charge and

what will be its revenue per customer if it wants customers to buy only channel

A? Which way does Comcast make more money?

2) Consider the Example shown in Table 1 of the Advanced Topics in Pricing chapter

and discussed in lecture.

a) Explain why bundling is more profitable than selling the two goods separately.

b) If products A and B could be resold at very low transaction cost, how would this

undermine the bundling strategy?

3) Explain in words what is required for a predatory pricing strategy to be successful.

4) Do you think that if Firm E observes that an incumbent monopoly charges $10,000 in

a market and Firm E’s minimum average cost is $6,000 that E should enter?

Economics 121 Page 2

5) Predatory Pricing

c) Explain figure 11.1 below. What does box B represent? What about Box A?

d) As drawn, box B is bigger than box A. What does this imply about whether

predatory pricing is a credible and workable strategy according to the book?

What is your view on that question?

e) Could it be that Box A is taller than Box B in a figure like figure 11.1 but with

different cost curves? (In answering this question, we have in mind a situation

where the two firms have identical cost curves, but not necessarily shaped like

those in Figure 11.1) If Box A were taller than Box B, does that mean that the

incumbent might actually lose less money at its high production than the entrant

does at its low production?

6) Consider the Delta Dental example from the raising rivals’ cost lecture. Assume that

a typical dentist serves 30 patients per week at $100 per visit and 10 of these patients

have Delta Dental insurance. Assume the dentist has an opportunity cost of time

equal to $70/hour and it takes one hour to see each patient.

a) Assume Delta does not have an MFN (Most favored nation) clause in its

contracts. If an entrant Dental Blue offers this dentist the ability to serve its

insureds at $85/visit and says it can probably provide 1 or more new Dental Blueinsured

patients, will the dentist accept Dental Blue’s offer?

b) Continuing from part (a), can Dental Blue get a large network of dentists when

Delta does not have MFNs?

c) Will Dental Blue be able to offer an attractive insurance policy to employers?

Economics 121 Page 3

d) Now assume that Delta Dental has an MFN. How many patients will Dental Blue

need to deliver a dentist to make it worth signing up with Dental Blue? If Dental

Blue wants a dentist network as large as Delta’s to be competitive, compare the

number of employers Dental Blue will need to sign up to the number that Delta

has signed up?