Question 16
Problem 17 In class, bundling has been pitched as a form of price discrimination. Since price discrimination is vulnerable to competition, it would seem that there is no reason to see bundling in competitive markets, unless dictated by transaction costs or economics of manufacturing. Nevertheless, ATFJ' T at one point switched to offering all of its telephone services as a bundle. Further, the market that ATE? T was serving was commonly thought of as being competitive. Is there method to this madness? Consider the following model. Two competing rms make identical products {called widgets) with unlimited capacity. In addition, each rm. can choose to sell a repair contract that goes along with each widget sold. Both rms have the same manufacturing costs: widgets cost $0. 50 per unit to produce, and each repair contract sold costs its seller $0.10. The market consists of 100 buyers each of whom has a reserve price of $3 for one widget. However not all buyers value the repair contract in the same way. The reservation price (RP) of half the buyers for the service contract is $0.05 cents and for the other half it is $0.85 cents. Given prices posted (simultaneously) by the rms, buyers will make the purchase that maximizes their consumer surplus. (If buyers in any one market segment are indi'erent between the two rms, half go to one rm, halfgo to the other.) Each buyer is interested in at most one widget and at most one repair contract. 1. Consider a one-shot game where each rm. sells both widgets and repair contracts separately and buyers can choose to buy none, one or both products. What prices would each rm announce for widgets and repair contracts in equilibrium? 2. Consider a one-shot game where each rm sells widgets and repair contracts as a bundle. Buyers can choose to buy the entire bundle or not. What prices would each rm announce for its bundle in equilibrium? 3. Now suppose Firm 1 prices and sells widgets and repair contracts separately while Firm 2 bundles widgets and repair contracts. In this situation Firm 1 must announce two prices {one for the widgets and the other for the repair contracts) while Firm 2 announces a single price (for its bundle of widgets and contracts). Would prots of BOTH rms in equilibrium be positive? HINT: You do not need to determine the equilibrium prices to answer this question. Consider only whether or not the rms could be stuck making zero prot in equilibrium. 4. 0f the three scenarios above, which is the most protable for the rms? Give an intuitive explanation of why. Problem 16 There are two rms A and B located in different regions that produce an identical good at zero cost. Each region is inhabited by a single buyer interested in purchasing at most one unit of the good. The RP of each buyer for one unit of the good is $5. If a buyer purchases the good from the seller in the distant location she incurs a transportation cost of $2.60. Buyer's will purchase from the location that results in the largest surplus. In case of ties, buyers break them in favor of the closest seller. 1. If the sellers are restricted to announcing a single price per unit for their goods, is pricing at cost (i.e. 0) for both rms an equilibrium? Explain. - . If the sellers are restricted to announcing a single price (simultaneously) per unit for their goods, what will the equilibrium price be? Explain. . What is the e'ect on protability, and why, if each rm can also issue a coupon (production and distribution of coupon is costless) that will be directed to buyers in distant regions? So, A will issue a coupon to the buyer who resides in the same region as B. Similarly, B will issue a coupon to the buyer who resides in the same region as A. . What would the equilibrium price and value of a coupon be under the above arrange- ment
