Assignment 2, ECON 6921. The assignment is due 2/24 at the start of class. 105points. Late assignments will be penalized.

1. (10)Thenational market shares for U.S. airlines in 2013were as follows:

AirlineMarket Share

Delta 16.3%

United 15.7%

Southwest 15.4%

American 12.8%

US Airways 8.4%

JetBlue 5.1%

Alaska 4.1%

a.)(3) Use this information to calculate the Herfindahl - Hirschman Index(HHI) in this industry (assume any of the smaller airlines not listed have a negligible effect to the HHI).

b.)(3) Since 2013, American and US Airways have merged. What does the post-merger HHI equal?

c.)(4) Suppose United and Southwest announce plans to merge in 2015. Given the DOJ guidelines regarding market concentration we discussed in class, do you think this merger would be approved? What else would the DOJ consider besides the national market shares?

2. (20) Firm’s A and B live on adjacent plots of land. Each has two potential uses for her land, the present values of each of which depend on the use adopted by the other, as summarized in the table. All the values in the table are known to both parties.

Firm A

Used Car SalesSoybean Farming

Firm B / Flea Market / Firm A’s Profit = $15 million
Firm B’s Profit = $15 million / Firm A’s Profit = $14 million
Firm B’s Profit = $13 million
Farmer’s Market / Firm A’s Profit = $17 million
Firm B’s Profit = $14 million / Firm A’s Profit = $16 million
Firm B’s Profit = $17 million

a) If the two firms choose simultaneously, what activities would they pursue and what are their expected profits? Does this represent a prisoner’s dilemma?

b) If firm A chooses a maximin strategy, what is the expected outcome?

Suppose this is a mixed strategy game. Firm B has a 50% chance of selecting either flea market or farmers market, while Firm A has a 30% chance of selecting used car sales and a 70% chance of selecting soybean farming.

c) What is the expected payoff to Firm A?

d) Given Firm B’s selection probabilities, should Firm A alter its selection probabilities? If so, how?

3. (15) Read the following article regarding review incentives from the New York Times use it to answer the following questions:

a. ) Construct a sequential game in which a customer and a provider have the option of giving either a positive or a negative review to one another. Make the customer the first mover and the provider the second mover.

b.) Suppose the passenger received bad serviceand would like to give a negative review to the provider. However, the customer knows that if he gives the provider a negative review, the provider will respond by giving him a negative review. Create payoffs(which could represent profit or utility) for both the customer and the provider such that the Nash equilibrium is what is described in the article as “the Barney world.”
c.) Do you think this situation represents a prisoner's dilemma? Briefly explain.

4. (15) Suppose two clothing manufacturers, Lands’ End and L.L. Bean, market their goods strictly by mail order. Each produces an essentially identical field coat. The cost of producing such a coat is $100. Because the field coats are perfect substitutes, customers will flock to the seller that offers the lowest price. If both firms offer identical prices, each receives half the customers. The two firms have the choice of pricing at whole-dollar prices of $103, $102, or $101. Market demand at $103 is 100 coats; at $102, 110 coats, and at $101, 120 coats. The profit each firm would earn at various prices (Lands’ Ends Profit, LL Bean’s Profit) is shown in the payoff matrix below.

LL Bean
$103 / $102 / $101
$103 / ($150, $100) / ($0, $220) / ($0, $120)
Lands' End / $102 / ($220, $0) / ($110, $110) / ($0, $120)
$101 / ($120, $0) / ($120, $0) / ($60, $60)

a. What is the Nash equilibrium of this game?

b. Suppose Lands’ End and L.L. Bean decide to collude and jointly determine prices. If each firm acts as profit maximizer, is this collusion likely to work. Briefly explain why or why not. Note: Don’t worry about whether or not they get caught by the government.

c. Suppose that in hopes of raising prices, L.L. Bean decides to announce the price for its coat early in the summer (before Lands’ End announces their prices). Will this strategic move be successful for LL Bean? Briefly explain why or why not?

5. (15) Read the following story from Time: then answer the following questions.

a. Briefly explain why online retailers are more inclined to price discriminate compared to brick and mortar retailers.

b. The story notes that some sites charge higher prices to new customers, while other sites charge higher prices to returning customers. Briefly explain what this decision depends on (specifically, what factors will an online retailer consider before making the decision of whether to give a discount or charge a premium to new customers)?

c. Given what the article states about Orbitz and Cheaptickets, what do you know is true regarding the price elasticities of returning customers vs. new customers?

6.(10) Owners of a Regal Theaters have determined that the elasticity of demand for movie tickets equals -1.8 for senior citizens and –1.6 for adults under age 65.

a. If the owners of Regal Theaters price discriminate, who should be charged a higher price? Briefly explain why.

b. Use the Lerner index to determine the ratio of prices. In percentage terms, how big a price premium should be charged to the group that pays the higher price?

7. (20) Microsoft sells two types of office software, a word processor it calls Word, and a spreadsheet it calls Excel. Both can be produced at zero marginal cost. There are two types of consumers for these products, who exist in roughly equal proportions in the population: authors, who are willing to pay $120 for Word and $40 for Excel, and MBA students, who are willing to pay $50 for Word and $150 for Excel.

a. Ideally, Microsoft would like to charge authors more for Word and MBA students more for Excel. Why would it be difficult for Microsoft to do this?

b. Suppose that Microsoft execs decide to sell Word and Excel separately. What price should Microsoft set for Word? (Hint: Is it better to sell only to authors, or to try to sell to both authors and MBA students?) What price should Microsoft set for Excel? What will Microsoft’s profit be from a representative group of one author and one MBA student?

c. Suppose that Microsoft decides to bundle together Word and Excel in a package called Office, and not offer them individually. What price should Microsoft set for the package? Why? How much profit will Microsoft generate from a representative group of one author and one MBA student?

d. Does bundling allow Microsoft to generate higher profit than selling Word and Excel separately?