Assignment

1. Consider a wholesaler and a retailer selling designer handbags. Each has market power. The wholesaler sells designer handbags to the retailer, which then sells the handbags to consumers. The demand for handbags is captured by P = 24-Q. Assume that the marginal cost of producing a handbag is constant (MC=$8). Consider the following scenarios:

a. Suppose that the retailer is the only firm and that it can produce the handbags it sells (there is no wholesaler here). How many handbags will be produced and what price will be charged? Draw a graph and show these points on the diagram.

b. Now suppose that the retailer cannot produce handbags and must instead buy them from the wholesaler. The wholesaler charges the downstream firm $16 per handbag. How many handbags will the retailer purchase and sell, and what price will the retailer charge?

2. If the wholesaler and retailer in problem 1 merged, what would be the effect on overall social surplus?

3. Discuss the problem of double marginalization. What is it? What causes it? How is it mitigated by a vertical merger?

4. Define first degree price discrimination, second degree price discrimination, and third degree price discrimination. Provide an example of each.

5. We have seen how monopolistic industries can result in a deadweight loss relevant to the competitive outcome. Consider the case of a monopolist engaging in first degree (perfect) price discrimination. How do you think the profits of the monopolist and overall social welfare are affected compared to the case where the monopolist sets a single monopoly price? (Hint: try drawing a simple diagram in both cases).