EC3260

UNIVERSITY OF WARWICK

Summer Examinations 2018/19

Industrial Economics 2: Strategy & Planning

Time Allowed: 2 hours

Answer ALL FOUR questions (25 marks each). Answer questions 1 and 2 in one booklet and
questions 3 and 4 in another booklet.

Approved pocket calculators are allowed.

Read carefully the instructions on the answer book provided and make sure that the
particulars required are entered on each answer book.

1. Two firms and with differentiated products compete on prices. Fixed costs are zero
and both firms have constant marginal cost = 1. Their demand functions are:

= − +

=( − + )

where > 1. Each firm has an owner and a manager. Owners want to maximise profit
( ) and managers have payoff functions

= + (1 − )( )

= + (1 − )( )

where is nonnegative for firms and . Both owners move first and simultaneously
pick ≥ 0 and ≥ 0. The managers observe both and before simultaneously
making pricing decisions and .

(a) Derive the second stage Nash equilibrium in prices , given incentive choices
( , ) from stage one. (7 marks)

(b) Find the optimal choices of and at stage one. Are profits lower or higher when
compared to the standard case ( = = 1)? (11 marks)

(c) Illustrate using diagrams how the optimal incentives found in part (b) would
influence the behaviour of two Cournot competitors if now ≥ 0. Would this be an
improvement over the standard Cournot equilibrium ( = 1)? (7 marks)

1 (Continued overleaf)
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2. A theme park of unobservable quality opens. Quality is either = 2 or = 1 but

neither buyers nor the theme park can observe quality.

If a buyer visits the theme park they receive a payoff of + − where ~ [0,1]
and ∈ { , }. If they do not visit then they receive payoff = 1.

(a) Find the expected demand for tickets as a function of the price per ticket , [ ]
and the number of buyers . Find the seller’s optimal price ∗ and their expected
profit if costs are zero. (6 marks)

(b) Suppose is equally likely to be or but a reviewer publishes a review of the

theme park. The reviewer incorrectly assesses the true level of quality with
probabitilty < 1/2 and correctly assesses it with probability 1 − .

(i) What is a buyer’s conditional expectation of after seeing either a good review
or a bad review? (6 marks)
(ii) How does the expected revenue for the theme park change with ? Explain the
intuition behind this. (6 marks)

(c) What are some of the problems associated with relying on 3rd parties to certify
quality? Discuss with reference to all the material mentioned in lectures. (7 marks)

Please use a separate booklet

3. Consider a market with two platforms, “old” and “new”, that connect between a buyer
and a seller. Suppose that if the buyer and the seller use the old platform to trade, the
buyer's payoff is 10 and the seller’s payoff is 30. If, however, the buyer and the seller
use the new platform to trade, the buyer’s payoff will be 20 and the seller’s payoff will
be 40. The buyer and the seller cannot interact without joining a platform, and if they
join different platforms their payoffs are 0. The old platform cannot charge access prices
and is not a strategic player. The new platform is a strategic player that can charge
access prices, from the buyer and from the seller, which can be positive or
negative. The platform cannot charge transaction fees.

In the first stage, the new platform sets the two access prices. In the second stage, the
buyer and the seller observe the two access prices and choose simultaneously which
platform to join.

(a) Suppose that the new platform suffers from “unfavorable beliefs”. Solve for the
optimal divide-and-conquer strategy for the new platform. What are the new
platform’s profits? (5 marks)

2 (Question 3 continued overleaf)

EC3260

(b) Suppose that the new platform enjoys “favorable beliefs”. What will be its optimal
access prices and its profits? (5 marks)

(c) Now suppose that initially the new platform suffers from unfavorable beliefs but by
investing a fixed fee, F, it can change the beliefs to become favorable. Further
assume that if the new platform makes the investment, the payoffs of both the
buyer and the seller from trading within the old platform go down by 5. What is the
highest F that the new platform will be willing to pay? (7 marks)

(d) Answer again parts (a) and (b) above under the assumption that in addition to the
access fees that the platform can charge both the buyer and the seller, the platform
can also charge the buyer (but not the seller) some transaction fees. (4 marks)

(e) Answer again parts (a) and (b) above under the assumption that in addition to the
access fees that the platform can charge both the buyer and the seller, the platform
can also charge the seller (but not the buyer) some transaction fees. (4 marks)

4. Consider a horizontally differentiated product market in which two firms are located at
any points and on the linear city and assume ≤ . Firms produce at marginal
costs . There is a continuum of consumers of mass 1 who are uniformly distributed on
the unit interval. They have unit demand for the differentiated product. A consumer
located at [0,1] obtains utility = − ( − ) − if she buys one unit from
firm 1 and = − ( − ) − if she buys the product from firm 2.

(a) Suppose that prices are regulated at = 2 . In the game in which firms
simultaneously decide where to locate their product, characterize the Nash
equilibrium. Explain your answer. (5 marks)

(b) Determine the demand function for each firm for each admissible price pair ( , )
given locations and . (3 marks)

(c) Suppose that the two firms simultaneously set the prices. Determine the market
equilibrium prices for all possible combinations of and . (12 marks)

(d) Compare your results obtained in (a) and (b) for locations = 0 and = 1/2. Is
the equilibrium socially efficient? Depending on your answer elaborate on the
source of inefficiency or give reason for efficiency. (5 marks)

3 (End)