EC2080 THE UNIVERSITY OF WARWICK Summer Examinations 2011/12

Industrial Economics 1: Market Structure

Time Allowed: 1 Hours Answer ALL questions from Section A (20 marks each) and BOTH questions from Section B (40 marks in total). Read carefully the instructions on the answer book provided and make sure that the particulars required are entered on each answer book.

Section A

1. Magna Company must decide whether to buy all or part of its aluminum from the Steele Corporation. At the same time, Steele must decide whether or not to provide prompt delivery, which is more costly. If Steele Corporation provides prompt delivery of the aluminum it sells Magna, then Magna will make $2 million if it buys all its aluminum from Steele and $1 million if it buys only part of its aluminum from Steele. But if Steele provides slow delivery, then Magna will lose $5 million if it buys all its aluminum from Steele and lose $1 million if it buys only part from Steele. If it receives an order for all of Magnas aluminum requirements, then Steele will make $3 million if it provides prompt delivery and $4 million if it is slow. If it receives an order for part of Magnas aluminum requirements, then Steele will make $1 million if it provides prompt delivery and $2 million if it is slow. a. Magna must decide whether to buy all or part of its aluminum from Steele, and Steele must decide whether or not to provide prompt delivery. What is the payoff matrix for this game? (7 marks) b. Does any player have a dominant strategy? If so, what is it? Briefly explain. (6 marks) c. Does this interaction have a Nash equilibrium? If so, what is it? Briefly explain. (7 marks)

2. Augustin Cournot studied the town of Ale, which has two water producers, A and B. The demand for water by Ale residents is given by P = 12 Q where P is in pounds per pint and Q is in thousands of pints. Water is produced at zero cost. If A and B choose quantities QA and QB to supply, how much will they supply in equilibrium, and what is the market price? (20 marks)

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EC2080

Footspring is a producer of tablet PCs. Footspring has an upstream division that produces the operating system for such devices. Footspring has a downstream division that assembles tablet PCs. The demand curve for Footsprings tablet PCs is given as Q = 300 - P where Q is the quantity of tablets it will sell when it sets its price equal to P. All prices are in pounds, while quantities are in thousand units. Each tablet costs 100 to produce, excluding the cost of the operating system. It does not cost anything for Footspring to make an extra copy of the operating system. a. Assume that the downstream divisions manager maximizes divisional profits in a transfer price system. What is the Net Marginal Revenue of the downstream division? (5 marks) b. How should top management optimally set the transfer price that the downstream division has to pay the software division for each copy of the operating system it sells (i.e. for each tablet with that operating system it sells). How many tablets will the downstream division produce? What are Footsprings profits? (5 marks) c. Assume that due to anti-trust actions, Footspring must be split into a software division, which retains the name Footspring, and an independent tablet producer, called Toehold. How much will Footspring charge Toehold for each operating system copy now? (5 marks)

d. How do the joint profits of Toehold and Footspring compare to Footspring's profit before the spin-off? Explain (give a reason) for the difference you see. (5 marks)

Section B

4.

Decide whether each of the following statements is True, False, or Uncertain, and give a brief but clear explanation of your answer. (Most or all of the credit will be given for the explanation.) a. Suppose a firm has market power and economies of scale. At the profit maximizing level of output, its marginal revenue will be less than its average cost. (8 marks) b. Saudi Arabia is critical to OPECs ability to function. (8 marks)

5.

Please give brief but clear answers to the following two questions. (i) Explain why firms might be inclined to make goods of inefficiently low durability. (12 marks) (ii) If firms were to rent rather than sell durable goods, would you expect them to be more or less durable? Explain your reasoning. (12 marks)

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