QUESTION III (26 points) A large technology Company decides to create an entrepreneurship friendly space, where small enterprises can operate in close proximity to one another. To create this space, which will be called Zone Forty-Two, the Company will construct office space, which will be rented to tenants for free. The Company is considering two start-up firms, B Enterprises a business software producer) and M Enterprises (a medical software producer). Both firms are currently located in different small towns of California, where they work out of their homes hence pay no rent. The sales volume for a firm if it locates at Zone Forty-Two depends on whether the other firm is also present. These sales volumes, along with the firms' sales at their current home locations, are presented in Table 1. Table 1 Sales Volume at Home-Town Zone Forty-Two Zone Forty-Two locations (alone) (with other firm) $600 $600 $670 $700 $700 $950 B Enterprises M Enterprises (a) Give an intuitive explanation why the sales figures are in the last column of Table 1 differ from the first two columns of the table. Hint: Elaborate on different types of economies that are likely to benefit firms locating next to each other in Zone Forty-Two. (4 points) To decide where to locate, firms compute their profits in the different locations. Profit equals sales minus labor cost. A problem is that labor costs for both firms are higher at Zone Forty-Two than in their home-towns, are listed in Table 2. Table 2 Labor Cost at Home-Town Zone Forty-Two locations $400 $420 B Enterprises M Enterprises $400 $500 (b) Calculate the profits for each firm under the various location-condition combinations as represented in the following table. Write answers in the table and show your calculations in space provided below the table: (9 points) Home-Town locations Profits at Zone Forty-Two (alone) Zone Forty-Two (with other firm) B Enterprises M Enterprises Using data from the table on profits that you just constructed, answer the remaining questions. (c) The Company invites the prospective tenants to apply for space at Zone Forty-Two. Not knowing who else will occupy the park, each firm assumes the worst that is it will end up alone at Zone Forty-Two. Under these circumstances, which firms (if any) will apply for a site? Use the calculations made in (b) above to support and explain you answer. (5 points) (d) Suppose now that the Company guarantees each firm that if it occupies the park, the other firm will surely be there. In other words, B Enterprises is told that if it chooses to locate at Zone Forty-Two, it is certain to find M Enterprises as its neighbor, and vice versa. Assume that the prospective tenants believe this guarantee is fully credible. In this case, would they apply for sites at Zone Forty-Two? Use the calculations made in (b) above to support and explain you answer. (5 points) (e) Suppose the firms' managers are doubtful about the Company's promise of full occupancy of Zone Forty-Two. The Company then seeks some other approach, and agrees to allocate $30 (in total) towards Zone Forty-Two. At first this seems like a trivial amount of money, but the Company's Financial Officer figures out that if the money is cleverly used in the form of a start-up grant, then they might be able to achieve full occupancy of Zone Forty- Two. Can you see how to achieve this end? If so, explain exactly how the money should be used. (3 points)