Assignment

1. Read the April 2002 Wall Street Journal article: "How to Beat Priceline: New Sites Post Secret Bids-Bargain Hunters Can See Exactly What Winners Have Paid for Cheap Trips" posted under the "Problem Sets" section of the course website.

(a) An identical hotel room appears to sell for one price if booked through the hotel and a different, lower price if booked through Priceline. What may account for the difference in the two prices (more than one factor may be potentially relevant)? Be as specific and complete as possible.

(b) Describe any differences between the hotel and Priceline in their incentives for preventing customers from posting the price they paid on Priceline for a room in a specific hotel.

2. Suppose Volvo can produce a new sedan with the cost function:

C(Q) = 50000 + 15Q

These sedans are sold in the European and U.S. markets. Demand is given by:

Q_E = 18000 - 400P_E             Q_U = 5500 - 100P_U

where E denotes Europe and U denotes the U.S. All prices and quantities are in thousands. Assume that it costs Volvo the same amount to produce and deliver a car for sale in the U.S. as in Europe.

(a) Show that Volvo's total demand, if the two markets are treated as one, is given by:

Q = 0                                   if P ≥ 55
Q = 5500 - 100P                   if 45 ≤ P < 55
Q = 23500 - 500P                 if P < 45

(b) If Volvo must set a single price (i.e. the same price in both the U.S. and Europe) for its new sedans, what price should it set, what will be the quantity sold in each market, and what are Volvo's profits and total consumer surplus?

(c) Now suppose that Volvo is able to restrict U.S. sales to authorized Volvo dealers only, and at the same time is successful in lobbying the European and U.S. governments to make it illegal for a consumer or dealer to ship Volvo sedans from Europe to the U.S. What quantity of sedans should Volvo sell in each market, and what will be the price in each market? What are total profits and consumer surplus? Why does this differ from the optimal price and quantity you found in (b)?

(d) Now suppose that Volvo's lobbying power isn't as strong as in case (c), and that individual consumers wishing to purchase a car in Europe, retrofit it to meet U.S. regulations, and ship it to the U.S. can do so and incur an additional cost of about $2 thousand. Given this possibility of costly arbitrage, what quantity of sedans should Volvo sell in each market, and what will be the price in each market? What are total profits?

3. Consider a coffee shop that has two types of customers: lawyers and doctors. The demand for espresso by lawyers is given by Q^L = 18 - 3P, where P is measured in dollars and Q is measured in ounces. The demand for espresso by doctors is given by Q^D = 10 - 2P. There are equal numbers of lawyers and doctors. The marginal cost of an ounce of espresso is $2.

(a) Suppose that the coffee shop can identify which customer is a doctor and which is a lawyer. The shop will offer each type of customer a specific size cup of espresso for some total price. How many ounces of espresso will lawyers be offered, and at what total price? How many ounces of espresso will doctors be offered, and at what total price? (HINT: you should find that lawyers are offered a 12 ounce drink for $48, and doctors are offered a 6 ounce drink for $21. Lawyers and doctors are both tired and rich!)

(b) Suppose that the shop owner can no longer distinguish the lawyers from the doctors (e.g., the doctors don't put on their white coats before getting their espresso). Suppose the shop still offers the two options you found in part (a). That is, each customer has the option of paying $21 for 6 ounces or $48 for 12 ounces. How will the customers respond?

(c) Keeping the drink sizes the same (6 ounces and 12 ounces), how should the coffee shop owner change the total prices of the two drinks so that lawyers will buy the lawyer option and doctors will buy the doctors option, and profits are maximized?

(d) Describe qualitatively how the coffee shop owner should change the drink sizes (and then the prices) to increase profits even further, while still ensuring that lawyers will buy the lawyer option and doctors will buy the doctors option.

(e) Suppose that the coffee shop owner could only charge a single, uniform two-part tariff to all customers. That is, both lawyers and doctors pay the same cover charge C and per-ounce price p. Describe qualitatively what C and p should be if the shop owner maximizes profits. Can you put upper and / or lower bounds on C and / or p?

4. High Street in Columbus, Ohio is exactly 5 miles long. Urban Meyer plans to sell Ohio State Buckeyes 2014 National Champion t-shirts to customers on High Street, and he has the right to do so as a monopoly. There are 1,000 Ohio State football fans spread out evenly on the street, and each fan values the t-shirt at $5. It costs every fan $1 per mile he or she has to walk to get to a shop selling the t-shirts. Each shirt costs $0.50 to make, and each shop costs $40 to set up. How many shops should Urban Meyer set up, and what will be the price of a t-shirt at each shop?

Attachment:- Lecture-Notes.rar