There are two firms 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 firms an equilibrium? Explain.

2. If the sellers are restricted to announcing a single price (simultaneously) per unit for

their goods, what will the equilibrium price be? Explain.

3. What is the effect on profitability, and why, if each firm 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.

4. What would the equilibrium price and value of a coupon be under the above arrange-

ment?