For many years, the American sportswear market has been dominated by two firms: a local producer Mikey and a foreign firm Eddie Dance. The marginal cost of producing and delivering one unit for Mikey is $20. The cost structure of Eddie Dance is unknown; what is known, however, is that it has run a marketing campaign "Under 40? Buy for $40!" which has essentially committed Eddie Dance to sell at a price of $40 a unit.

The marketing department at Mikey has estimated the demand curve for Mikey and found it to be:

q_m=100-2p_m+p_e

where p_m and p_e are prices of Mikey and Eddie Dance, in dollars per unit, an q_m is quantity demanded, in millions of units, per year.

a.How much should Mikey charge for a unit? What is the quantity sold and what is the profit in this case?

Mikey has hired you as a consultant to get advice on potential scenarios that might arise in the future. Consider each of the following scenarios independently.

For the remainder of this question (parts (b)-(f)), explicit calculations are not required (or even possible). However, please clearly explain your reasoning.

b.Rumors tell you that the board of directors of Eddie Dance is mulling abandoning its marketing campaign, and to subsequently lower the price. If that rumor materializes, would Mikey want to raise its price, lower its price, or keep its price the same?

c.Mikey is considering relocating production overseas. This would reduce Mikey's marginal cost considerably. Would Mikey find it optimal to increase the price, decrease it, or keep the same? What would happen to Mikey's profits?

d.The marketing department at Mikey tells you that a substantial number of customers buy Mikey (as opposed to Eddie Dance) precisely because of local production. If Mikey moves production overseas, these customers are likely to stop buying from either company (but, of course, the marginal cost would still go down, as specified in part c). The exact number of such customers is unknown. In this scenario, would you advise Mikey to raise the price, lower it, keep the same, or there is not enough information? What can you say about profits?

e.Software giant A-robe has developed software that would help automate the design of new garments. It is projected that it would save Mikey $10,000,000 a year. If Mikey acquired this software, would you advise Mikey to raise the price, lower it, or keep the same? What is the maximal price that Mikey should be ready to pay for a yearly license? How would your answer change if you knew that Eddie Dance is also planning to acquire the license?

f.Consider the same scenario as in e) and, moreover, you positively know that Eddie Dance is going to acquire the license. In addition, you are told that if both companies acquire the license, this would result in more similar product design (because of using the same software!) and this would weaken horizontal differentiation between the firms. With this in mind, if Mikey purchases the software, should it expect to raise its price, lower it, or keep the same? What is the maximal price that Mikey should be ready to pay for a yearly license in this case?

Hint: Remember that Eddie Dance is still true to its marketing campaign!