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Contract Theory: Problem Set 1

30 March 2018

Problem 1. A seller has m units of a good to sell. The value of each unit to the seller
and the buyer are

vs vb
s=L 30 40
s=H 50 70

Table 1: Distribution of Values

All m units have homogeneous quality. They are of high quality (s = H) with probabil-
ity 0.4 and of low quality (s = L) with probability 0.6. The buyer knows the distribution
of the state s.

1. Suppose the seller knows the realization of state s and offers a take-it-or-leave-it
price to the buyer. What is the equilibrium price and trading quantity?

2. Suppose the seller observes the realized state of nature s after a sales contract is
signed with the buyer. What is the second-best contract from the seller’s point of
view?

3. Suppose ex post the seller can not commit to the contract it offers in [2]. Does this
freedom increase the seller’s profit over the case in [1]? Why (not)?

Problem 2. A monopolist faces a customer who is one of two possible types, with equal
probability, described by the utility functions:
Z x
Ui (x, T ) : = Pi (y)dy − T, i ∈ {1, 2}
0
1
P1 (x) : = 1 − x, P2 (x) = 1 − x.
2
The monopolist’s cost function is C(x) = 0. The customer’s reservation utility is 0.

1. Compute the seller-optimal quantities and prices under perfect price discrimination.

2. Suppose the monopolist can not price discriminate. Compute the seller-optimal
linear price and quantities.

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3. Suppose the monopolist is restricted to adopt a single two-part tariff (t, f ), where
t is the unit price and f the lump-sum fixed fee. Compute the optimal tariff if the
seller intends to serve both types of customers.

4. Suppose the monopolist decides to serve the high type only. What is the seller’s
optimal tariff if he uses two-part tariff? Does the monopolist’s profit increase in
comparison to the monopoly profit you obtain in [3]?