Problem Set - 4

1. The figure below shows the long run equilibrium for RJW Enterprise.
a) Calculate the profit maximizing output and price
b) Calculate the producers’ surplus and profit earned by the firm
c) What kind of a market is RJW operating in
d) List any two characteristics of this form of a market
Price

AC

18

MC

14

12
10

7 Demand

MR

10 18 20 Output

Ans: a) Profit maximizing output and price (14, 18).

b) Producers’ surplus = 0.5 x (14-7) x 18 = 63
Profit = 0
c) Perfectly competitive market.
d) e.g; large number of buyers and sellers. and perfect information.

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2. Please see the following table and answer the questions that follow

Demand for Software

Software Version Home Users Commercial Users
Disabled Version Rs 1500 Rs 2000
Full featured version Rs 1750 Rs 5000

Assuming that the marginal cost of providing the software is zero, list out potential
software pricing schemes and identify the profit for each of the cases. If you want to
maximize profit, which scheme will you adopt? What kind of price discrimination is
suggested here? Would self-selection be applicable? Why or why not?

Ans: The Software provider can have two pricing techniques- Sell separately or Sell as a
bundle. Here let us consider there are equal number of users of Home and Commercial
=100 and MC=0 for all the production is given.

If the producer tries to sell separately he will charge

1) P (1500,5000), Revenue = (1500 x 200) + (5000 x 100) = 800000.
Or, charge 2) P (2000,1750). So, revenue = (2000 x 100) + (1750 x 200) = 550000.

If, he choses sell as a bundle his revenue will be (1500 + 1750) x 200 = 650000.
Or, (5000 + 2000) x 100 = 700000.

Thus, selling separately and charging Rs.1500 for the Disabled version and Rs.5000 for
the Full featured version will earn him the maximum revenue and profit.

Note that the Commercial users have a higher willingness to pay for both versions of
software. Thus, there is a positive correlation between the preferences.

The price discrimination is of 2nd degree.

Self-Selection based on willingness to pay is ineffective.

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3. In the following game, all payoffs are listed with the row player’s payoffs first and the
column player’s payoffs second.

a) Is there a dominant strategy equilibrium? If yes, what is it?

b) Is there a Nash equilibrium? If yes, what is it? (if there are more than one, list all
possible answers.

Ans: 1) If NRG Bars decides to Sponsor Marathon then Vita Bars best response will be to
Sponsor Marathon.
2) If NRG decides to Sponsor TV Running Show then Vita Bars best decision will be to
Sponsor TV Running Show.
3) If Vita Bars decides to Sponsor Marathon then NRG’s best response will be to sponsor
TV running show.
4) If Vita decides to Sponsor TV running Show then NRG’s best response will be to
Sponsor Marathon.

So, there are no cases of dominance of a strategy for any player.

There will be no Nash equilibrium.

4. There are three consumers of a public good. The demands for the consumers are as
follows:
Consumer 1: P1 = 60 - Q Consumer 2: P2 = 100 - Q Consumer 3: P3 = 140 - Q where Q
measures the number of units of the good and P is the price in dollars. The marginal cost
of the public good is $180. What is the economically efficient level of production of the
good?

Ans: Total market demand for the public good = P1 + P2 + P3 = (60 – Q) + (100 – Q) +
(140 – Q) = 300 – Q. Economically efficient level of output occurs when,
300 – 3Q = 180 or, Q = 40

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5. X, Inc. and Y, Ltd. compete in the high-grade carbon fiber market. Both firms sell
identical grades of carbon fiber, a commodity product that will sell at a common market
price. The challenge for each firm is to decide upon a capacity expansion strategy.
Suppose it is well known that long-run market demand in this industry will be robust. In
light of that, the payoffs associated with various capacity expansion strategies that X and
Y might pursue are shown in the following table. What are the Nash equilibrium capacity
choices for each firm if both firms make their capacity choices simultaneously?

Ans: (Modest Expansion, Modest Expansion) is the Nash equilibrium capacity choice.