ECO 280-Industrial Organization Başak Horowitz
Midterm Exam
Instructions:
You have until Thursday March 25rd, 2021 by 11:59 pm (midnight) to submit your answers.
You are permitted to use the textbook, your lecture notes and homework assignments. However, you
are not allowed to cooperate with your classmates.
You will submit your midterm exam online via Assignments tab on Canvas in doc, docx, pdf or txt
format in a single document.
There are 4 questions in this midterm exam. Please answer all of them.
For each question, show your calculations step-by-step, explain your answers and reasoning clearly
(especially for yes or no questions) in order to receive full credit.
Make sure to state any assumptions you make.
GOOD LUCK!
1. Assume that a firm has two type of consumers: students and young professionals. The demand from
students is QS = 180−2p and the demand from young professionals is QY P = 300−2p. The marginal
cost of producing this product is $20.
(a) Suppose that the firm uses services of ID.me (a company that verifies whether the customer is a
student or not) to identify their customers so that they can charge different prices for students
and professionals. If the firm is maximizing their profits, what price they should charge to
students? What price they should charge to professionals?
(b) Suppose that the firm decides not to use services of ID.me and they are not able to differentiate
their customers. What is the optimal price for this firm if they are not able to engage in price
discrimination?
(c) What are the profits of this firm if they are able to engage in price discrimination? What are
the profits of this firm if they are not able to engage in price discrimination?
(d) By using your answers to part (c), how much would this firm be willing to pay to ID.me fo
their services?
2. Assume that a software company has two type of consumers: students and young professionals.
Even though the company knows that there are two different types of consumers, they are not able
to identify each consumer’s type. So, they decide to offer two different versions of the product, a full
and a light version, so that the consumers self-identify themselves. According to the market research,
the company determines that there are 1000 students and 1000 young professionals. Additionally,
each student is willing to pay $400 for the full version of the product and $300 for the light version,
which doesn’t have the full features. Each young professional is willing to pay $800 for the full version
of the product and $100 for the light version. For the firm, it costs the same to produce and sell
the different versions. The company’s marginal cost of producing and selling of a product is zero
(MC = 0).
(a) What is the optimal price for each version of the product?
(b) Suppose that the firm can offer an intermediate version of the product, instead of the light
version. Similar to the previous case, the marginal cost of producing and selling the intermediate
version is zero. The young professionals are willing to pay $600 for the intermediate version,
whereas the students are willing to pay $350. What is the optimal price for each version of the
product if the company offers only the full and intermediate versions?
(c) Is it better for the firm to offer intermediate version instead of the light version? Or should they
continue to offer the light version along with the full version?
3. Suppose that there are only two rideshare companies, Lyft and Uber, providing services in New York
City and they engage in Cournot competition, i.e., they simultaneously decide how much to produce
and the market price will be determined by the aggregate output. The market inverse demand
function is given by P = 480 −Q. Lyft has a marginal cost of production MCL = 10 whereas Ube
has a higher unit cost of production MCU = 20.
(a) Find the Cournot equili
ium. Find the market price and quantity produced by each firm.
(b) Graph the best response functions of each firm and show the Cournot equili
ium on the graph.
(c) Suppose that if Uber spends $2000 in new technologies, they can reduce their per unit costs to
MCU = 10. Should they invest in new technologies? Why or why not?
4. Suppose that there are two firms producing N95 face masks, 3M and Kimberly-Clark (KC). Assume
that N95 masks are identical and firms’ products are perfect substitutes, i.e., consumers prefer to
uy the masks with the lower price. The firms are engaged in Bertrand competition, i.e., they set
prices simultaneously. Each firm has a capacity constraint of producing 100,000 masks a month. If
the firms have the same price, then they share the market equally. Both producers have a marginal
cost of $1 per mask.
(a) Suppose that the pre-pandemic demand for N95 mask was Q = 100, 000 − 10, 000P per month.
How much does each firm sell in the Bertrand equili
ium? What is market price and what are
each firms’ profits?
(b) Suppose, because of the Coronavirus Pandemic, the demand for N95 masks increased to
Q = 320, 000 − 10, 000P . How much does each firm sell in the Bertrand equili
ium under the
new demand? What is market price and what are each firms’ profits?
(c) Suppose that if the firms buy more machines they can increase their monthly production capacity
to 150,000 masks. New machines will cost each firm an additional $50,000. Then, there are fou
possibilities:
Both firms increase their capacity to 150,000 per month per firm.
3M increases its capacity to 150,000 per month and KC’s capacity constraint stays at 100,000
per month.
KC increases its capacity to 150,000 per month and 3M’s capacity constraint stays at 100,000
per month.
Neither of the firms increase their capacity. Each firm has a capacity constraint of 100,000
per month.
Calculate the profits for the firms for each case and illustrate the game in a matrix form.
(d) What is the Nash Equili
ium of the game you provided in part (c)? Does any of the firms have
an incentive to buy new machines and increase their capacity?
(e) Now assume that the cu
ent consumer laws are preventing the firms from increasing the prices
during emergencies. So the firms cannot increase their prices above the pre-pandemic level you
found at part (a). Does any of the firms have an incentive to buy new machines and increase
their capacity? (Please explain your answer intuitively. You don’t need to do any calculations
nor represent the situation in a matrix form game.)
(Hint: Please pay attention to the capacity constraints and check if they are binding in each case.)