Industrial Economics (EBC4007)

Exam (rst chance) School of Business and Economics, Maastricht University 9.0012.00 hrs, April 7, 2011 (MECC)

Asymmetric duopoly

Consider two quantity-setting rms that produce a homogenous good and choose their quantities simultaneously. The inverse demand function for the good is given by P = a q1 q2 , where q1 and q2 are the outputs of rms 1 and 2 respectively. The cost functions of the two rms are C1 (q1 ) = c1 q1 and C2 (q2 ) = c2 q2 . (a) Compute the Nash equilibrium of the game. What are the market shares of the two rms? (b) Given your answer to (1), compute the equilibrium prots, consumer surplus, and social welfare. (c) Prove that if c2 decreases slightly, then social welfare increases if the market share of rm 2 exceeds 1/6, but decreases if the market share of rm 2 is less than 1/6. Give an economic interpretation of this nding.

Product Dierentiation

Consider a linear city of length 1, with two shops located at the end points (1 and 2 respectively). Both shops face the same marginal cost c > 0. To open up a shop a xed cost 0 < f < 1/2t is incurred. Consumers are distributed uniformly along the line and have linear transportation costs t. Consumers have unit demands and obtain a maximum surplus of s > c + 2t when consuming the good. Suppose rst that shop 2 located at 2 sets a price s t < p2 < s. (a) Show that shop 1 (located at 1) faces a kinked demand curve (Hint: it is enough to develop the argument graphically). Next suppose that the market is covered by both shops. (b) Derive the Nash equilibrium in prices pD . 1

Suppose now that the two shops are owned by one monopolist. The monopolist covers the market. (c) Argue that with two shops the monopolist sets a price pM = s t/2 and that 2 pM > pD . Let t/8 < f < t/4 and allow for entry in the middle of the line. The potential entrant faces the same marginal and xed costs as the incumbent shops. After entry the incumbent monopolist sets the same price pI for both shops. Whereas the entrant sets the price P E . (d) Show that the demand for the entrant is DE = 1/2t+p p . What is the demand t for the incumbent? What are the post entry prots for the entrant and the incumbent? Comment on the result.
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Repeated price competition with dierentiated goods

We consider a dierentiated duopoly with the rms competing in the prices of the two goods. The demand functions are given by 1 1 q1 = a p 1 + p 2 , q 2 = a p 2 + p 1 2 2 (or zero if these amounts are negative), and the rms have common marginal cost c, with 0 < c < a. (a) Derive the reaction functions and the equilibrium prices. Also compute the prots at equilibrium. (b) Derive the prices at which joint prot is maximized. Also compute the associated prots. Now assume that the rms play the game repeatedly (innitely long), with payos discounted by a common discount factor 0 < < 1. (c) Describe a subgame perfect equilibrium of this game, using trigger strategies, in which the rms oer the prices that yield maximal joint prot at each stage. Determine the minimal value of needed for this equilibrium to be sustained. 2

Asymmetric information

Consider two rms, an incumbent rm (rm 2) and a potential entrant (rm 1) in the same market. Firm 1 rst decides whether to Enter (E) or not (N). Next, having observed this move, if rm 1 has entered then rm 2 decides whether to prey (P) or to acquiesce (A). The payos to rms 1 and 2 are, respectively, 0 and 4 if rm 1 plays N; 1 and 2 if rm 1 plays E and rm 2 plays A; 1 and 1 if rm 1 plays E and rm 2 plays P. We only consider pure strategies. (a) Compute the normal form of this game and all Nash equilibria. Which one(s) is (are) (subgame) perfect? Now assume that rm 1 (the potential entrant) can be of two types, each with equal probability: a weak type (W) and a strong type (S). Firm 1 knows its own type but rm 2 (the incumbent rm) knows only the probabilities. The payos are as before, except when rm 1 is of type S and enters (E): in that case, the payos from P are 1 for each, and from A they are 2 for rm 1 and 0 for rm 2. (b) Does this game have a pooling perfect Bayesian equilibrium? If so, describe the strategies and the belief of rm 2 (the incumbent) about the type of rm 1. (c) Does this game have a separating perfect Bayesian equilibrium? If so, again describe the strategies and the belief of rm 2 (the incumbent) about the type of rm 1.