BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, PILANI

Hyderabad Campus
Second Semester, 2019-2020
Industrial Economics : ECON F314
Assignment-1

Date : 21/02/2020 Submission Time-28/02/2020 (class hours)

Weightage: 5% Max. Marks: 10

Instructions:
1. Answer all questions.
2. Answer all sub-parts of a question at one place otherwise it would not be evaluated.
3. If you are solving a numerical, show the steps involved. Writing mere answer will
not fetch marks.
4. Arguments and steps should be precise and complete. For each question, you need
to provide proof and proper explanation. 4. If you are drawing a diagram, keep it
neat and well-labeled.
5. The solutions can be hand-written or typed. In case of hand-written, write clearly
and properly; it should be on proper sheets with decent margins. Sheets should be
properly tied, you don’t need to put it in file cover as such.

1 Consider a durable good (say, car) monopoly case. The market demand is given by the inverse
demand function P = 100 − 5Q. For simplicity assume the lifespan of the goods, consumers
and the monopolist to be 2 periods. Also assume that the cost of production is 0. If the
durable good is rented, it needs to be serviced before it can be rented again. The servicing
cost of one durable good is 15. Compare selling and renting. What is optimal profit here? 1
Marks

2 Consider the dominant firm with fringe model. Suppose the market (inverse) demand function
is given by P = 100 − 2Qm . The supply curve of the fringe is given by P = 10 + 2Qf . The
marginal cost of the dominant firm is 12. Calculate the market price and fringe supply in the
equilibrium. Also draw suitable diagrams. 1 Marks

3 Consider the following market with 2 sellers (Bertrand game): inverse demand function-
P = 12 − Q2 . The Seller A can produce the good at the unit cost of 6 (T CA = 6q1 ) whereas
the seller B can produce it at the unit cost of 8 (T CB = 8q2 ). 1 marks

(a) Solve for Bertrand-Nash equilibrium prices and profits. Explain clearly.
(b) Suppose the seller A now develop an even cheaper technology, T CA = 2q1 . What will
be the new Bertrand-Nash equilibrium prices and profits?

4 Suppose that a monopoly can price discriminate between two markets: market 1, where the
demand curve is given by q1 = 2 − p1 , and market 2 where the demand curve is given by
q2 = 4 − p2 . Suppose that once the product is sold, it cannot be resold in the other market.
That is, assume that arbitrage is impossible, say, due to strict custom inspections on the
border between the two markets. Assume that the monopoly produces each unit at a cost of
c = 1. 1 marks

Industrial Economics A-1 Page 1 of 3

 (a) Calculate the profit-maximizing output level that the monopoly sells in each market.
Calculate the price charged in each market.
(b) Calculate the monopoly’s profit level.
(c) Suppose that markets 1 and 2 are now open, and all consumers are free to trade and
to transfer the good costlessly between the markets. Thus, the monopoly can no longer
price discriminate. Find the profit-maximizing value of p now.

5 A discriminating monopoly sells in two markets. Assume that no arbitrage is possible. The
demand curve in market 1 is given by p1 = 100 − q21 . The demand curve in market 2 is given
by p2 = 100 − q2 . We denote the monopoly’s aggregate production by Q where Q ≡ q1 + q2 .
The monopoly’s cost function depends on total production and is given by T C(Q) = Q2 .
Answer the following questions: 1 marks

(a) Calculate the monopoly’s profit-maximizing quantity sold in market 1 and market 2.
(b) Calculate the profit level of the discriminating monopoly.
(c) Suppose now that a new management assumed control of this firm. The young CEO
decides to decompose the monopoly plant into two plants, where plant 1 sells in market
1 only and plant 2 sells in market 2 only. Calculate the profit-maximizing output level
sold by each plant.
(d) Calculate the sum of profits of the two plants.
(e) Conclude whether this plant decomposition increases or decreases profit. Explain your
answer by investigating whether the above technology exhibits increasing or decreasing
returns to scale.

6 Consider the following game. What are the conditions for W being a dominant strategy for
country X as well Y ? Under what conditions (P, P ) can be a Nash Equilibrium? Write down
the best response functions for both players. 0.5 Marks

7 In the following game, find out the set of dominant strategies. Write down the best response
functions for both players.. Also find out the pure strategy Nash equilibriums. 0.5 Marks

Industrial Economics A-1 Page 2 of 3

 8 Consider the Traveler’s Dilemma, where two travelers returning home from a remote island
where they bought identical rare antiques find out that the airline has managed to smash
these rare antiques. The airline manager assures the passengers of adequate compensation.
Since the airline manager does not know the actual cost of the antiques, he offers the two
travelers the opportunity to write down separately on a piece of paper the true cost of the
antiques, which is restricted to be any number between 3 and 100.
Let ni denote that value stated by traveler i, i = 1, 2, and assume that the travelers cannot
communicate with each other during this game. The airline manager states the following
compensation rules: (a) If traveler i writes down a larger number than traveler j, (i.e.,
ni > nj ), then he assumes that j is honest and i is lying. Hence, in this case, the airline
manager will pay ni − 3 to traveler i, and nj + 3 to traveler j. Thus, the manager penalizes
the traveler assumed to be lying and rewards the one assumed to be honest. (b) If ni = nj ,
then the manager assumes that both travelers are honest and pays them the declared value
of the antiques. Find out the Nash Equilibrium of this game.. 1 Marks

9 Consider the market for a good X. There are 2 types of consumers, A-type and B-type.
There are 40 A-type consumers, each has a demand given by q A = 100 − P . There are 10
B-type consumers, each has a demand given by q B = 240 − 2P . The total cost of production
is given by T C(Q) = 50 + 20Q. The producer (seller) can’t identify a consumer’s type. In a
two-part tariff pricing (F, P ), what will be optimal entry fee and variable price? 1 marks

10 Consider the case of a durable good which last for 2 periods. There are 2 potential consumers,
A and B. A0 s valuation for the good is 45 per period and B 0 s valuation for the good is 20
per period. Compare selling vs. renting, what is the optimal profit? 1 marks

11 There are two firms, Entrant (denoted by E) and an Incumbent (denoted by I). Player E
moves first and plays either IN or OUT (i.e. comes into the market or stays out). If he plays
OUT, the game ends with payoffs 0 to E and 100 to I. Player I can observe what E has
played. If E plays IN, player I can either play FIGHT (F) or ACCOMMODATE (A) and
the game ends with payoffs (−10, 0) and (40, 50) respectively (the first payoff in brackets is
E’s payoff, and the second I’s). 1 marks

(a) Represent this situation as a game in extensive form.

(b) Write down the strategy sets for E and I.
(c) Derive the SPNE of this game, clearly showing the steps?
(d) Consider the following normal form version of this game: both E and I simultaneously
decide on their strategies SE = (IN, OU T ) and SI = (F, A). If the entrant picks OUT,
the pay-offs are always 100 for the incumbent and 0 for the entrant. Find the Nash
equilibriums of this game.
(e) Explain ‘credible strategies’ in this context.

Industrial Economics A-1 Page 3 of 3