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    Problem Set 5

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    gorski29
    This document contains two economics problems assigned as part of Problem Set 5 for the course Economics 121A Industrial Organization at an unnamed university. Problem 1 involves analyzing a three-stage game between an incumbent firm and potential entrant involving sunk costs and the threat of predatory pricing. Problem 2 examines the effects of a horizontal merger between two monopoly firms, one that manufactures an input (richets) and one that manufactures the final product (whatsits) requiring that input. Students are asked to draw extensive game trees, derive demand and profit functions, and calculate equilibrium prices and profits under independent and merged firm scenarios.

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    Problem Set 5

    Uploaded by

    gorski29
    437 views2 pages
    This document contains two economics problems assigned as part of Problem Set 5 for the course Economics 121A Industrial Organization at an unnamed university. Problem 1 involves analyzing a three-stage game between an incumbent firm and potential entrant involving sunk costs and the threat of predatory pricing. Problem 2 examines the effects of a horizontal merger between two monopoly firms, one that manufactures an input (richets) and one that manufactures the final product (whatsits) requiring that input. Students are asked to draw extensive game trees, derive demand and profit functions, and calculate equilibrium prices and profits under independent and merged firm scenarios.

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    This document contains two economics problems assigned as part of Problem Set 5 for the course Economics 121A Industrial Organization at an unnamed university. Problem 1 involves analyzing a three-stage game between an incumbent firm and potential entrant involving sunk costs and the threat of predatory pricing. Problem 2 examines the effects of a horizontal merger between two monopoly firms, one that manufactures an input (richets) and one that manufactures the final product (whatsits) requiring that input. Students are asked to draw extensive game trees, derive demand and profit functions, and calculate equilibrium prices and profits under independent and merged firm scenarios.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    437 views2 pages

    Problem Set 5

    Uploaded by

    gorski29
    This document contains two economics problems assigned as part of Problem Set 5 for the course Economics 121A Industrial Organization at an unnamed university. Problem 1 involves analyzing a three-stage game between an incumbent firm and potential entrant involving sunk costs and the threat of predatory pricing. Problem 2 examines the effects of a horizontal merger between two monopoly firms, one that manufactures an input (richets) and one that manufactures the final product (whatsits) requiring that input. Students are asked to draw extensive game trees, derive demand and profit functions, and calculate equilibrium prices and profits under independent and merged firm scenarios.

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    ECONOMICS 121A

    INDUSTRIAL ORGANIZATION
    SPRING QUARTER 2009
    PROFESSOR REQUENA

    PROBLEM SET 5

    DUE: JUN 3RD

    Problem 1. [Predatory conduct]


    Consider the following game with three stages between an incumbent and a potential
    entrant. The incumbent firm may incur in a sunk cost and may use it as a “threat” for price
    predation in case the potential entrant decides to enter the market (i.e. the incumbent will
    announce that she can incur in a sunk cost). The sequence of the game is as follows. In
    stage one the incumbent has to decide whether invest or not, with F=5, which is a sunk
    cost for the incumbent. In stage two, the potential entrant has to decide whether to enter or
    to remain outside the market. In stage three, and in the case of entry, the incumbent has to
    decide whether to accomodate to the entry (with profits πD=3 for both firms in the last
    stage) or to compete in prices, that is to “predate” (with loses of πG=-1, for both firms). In
    the stage three , if entrant does not enter the market, the incumben acts as a monopoly
    and obtain πM= 10.

    (A) Draw the extensive game (tree representation) and determine the Nash perfect
    equilibrium. Is the threat of price predation credible by the entrant?
    (B) How does the equilibrium change if F=3? Is the threat credible now?
    (C) Discuss alternative ways that the incumbent may use to provide credibility to the
    announcement of price predation..

    Problem 2. [Horizontal mergers and vertical relations]


    Norman International has a monopoly in the manufacture of whatsits. Each whatsit
    requires exactly one richet as an input and incurs other variable costs of $5 per unit.
    Richets are made by PepRich Inc., which is also a monopoly. The variable costs of
    manufacturing richets are $5 per unit. Assume that the inverse demand for whatsits
    is pw = 50 − qw , where pw is the price of whatsits in dollars per unit and qw is the quantity of
    whatsits offered for sale by Norman International.

    (A) Assume that the two monopolists act as independent profit-maximizing companies,
    with Norman International setting a price pw for whatsits and PepRich setting a
    price pr for richets. Hence, derive the profit-maximizing price for whatsits as a
    function of the price of richets, and use this function to obtain the derived demand
    for richets.
    (B) Use your answer in (A) to write down the profit function for PepRich. Hence, derive
    the profit-maximizing price of richets. Use this to derive the profit-maximizing price of
    whatsits. Calculate the sales of whatsits (and so of richets) and calculate the profits of
    the two firms.

    ( C) Now assume that these two firms merge to form NPR International. Write down
    the profit function for NPR given that it sets a price pw for whatsits. Hence, calculate
    the postmerger profit-maximizing price for whatsits, sales of whatsits, and the profits of
    NPR

    (D) Verify that this merger has increased the joint profits of the two firms while reducing
    the price charged to consumers. By how much has consumer surplus been increased
    by the merger in the market for whatsits?

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