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Mock End of Term Test 2013

Mock End of Term Test 2013

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Mock End of Term Test 2013
Mock End of Term Test 2013

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01/11/2014

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Page 1 of 6
ECO3041: Industrial Organisation.

(Mock) End of term test

There are two questions, you only need to answer one of them, but you should answer all the  parts of the question you choose. If you answer both questions, the highest of your marks will be taken, but I do not expect you will have time to do this. Points will be awarded for your workings as well as your final answer. I advise you to use a calculator that works with fractions rather than decimals. You may also  find it helps to work with letters rather than numbers for as long as possible. You have 90 minutes.
In the actual end of term test, I will just change the numbers.

Page 2 of 6
1.

Question 1
Sainsbury’s and Tesco are located at both ends of a one mile long street.
There are two types of shoppers
(called “high
-
value” and “low
-
value”)
, with equal numbers of each type. High-value shoppers obtain a value of
£

from buying a tub of Haagen-Dazs ice-cream, and an additional value of
£

of Sainsbury’
s Taste the Difference Maple Syrup as well, or an additional value of
£

if they buy a bottle of Tesco Value Maple Syrup as well. Low-value shoppers obtain a value of
£

from buying a tub of Haagen-Dazs ice-cream, and an additional value of
£

from buying either variety of maple syrup. All shoppers only obtain any value from the first tub of ice-cream and the first bottle of maple syrup they buy (so they will not buy more than one). No shoppers get any value from buying maple syrup without ice-cream, but they do still get value from buying ice-cream without maple syrup. Shoppers of both kinds are uniformly distributed along this street. Both kinds have linear transport costs, so that walking
miles costs them
£
in lost value. However, once they have been to either
Sainsbury’s or Tesco, they are laden
down with shopping, so they wish to just walk home. (I.e. you
may assume that the transport cost of visiting both Sainsbury’s and Tesco is infinite.)

For both Sainsbury’s and Tesco, Haagen
-Dazs has a constant marginal cost of
. Sainsbury’s Taste the
Difference Maple Syrup has a marginal cost of

for Sainsbury’s, and Tesco Value Maple Syrup has a
marginal cost of
for Tesco.
Sainsbury’s and Tesco cannot differentiate between the two types of
shopper based on observable characteristics. Sainsbury
’s charges

for Haagen-Dazs and

for their maple syrup. Tesco charges

for Haagen-Dazs and

for their maple syrup. You may assume the following parameter values. (These are the only things which will change in the actual test.)

= 5
,

= 2
,

=

,

= 3
,

= 1
,
= 2
,
= 1
,
=

,
=

. a) Assume that in equilibrium, all consumers buy both ice cream and maple syrup. How far from
Sainsbury’s
is the high-
value shopper who is just indifferent between buying from Sainsbury’s and buying from Tesco’s? How far from Sainsbury’s is
the low-value shopper who is just indifferent
prices.) (10%) b)
Given shoppers are visiting Sainsbury’s or Tesco anyway to buy ice cream, what must be true for
them to want to buy maple syrup as well? (Your answer may differ across types of shopper.) Explain why this means that
Sainsbury’s
will price maple syrup at either

or

(rather than any other price), and why Tesco will price it at either

or

, (rather than any other price). In each case, you do not have to say which of the two options the supermarket would choose. (10%) c) Suppose that both shops sell their brands of maple syrup at

.
Write down each supermarket’s
profits as a function of prices. (Hint: be careful to include the revenue from selling both ice-cream and maple syrup, to both high-value and low-
value customers. Don’t forget costs either!) Then derive their
optimal price for ice-cream. Y
ou should find that Sainsbury’s sell ice
-cream at
£

and Tesco sell it at

Page 3 of 6
£
94
. Explain intuitively why Sainsbury’s is charging a higher
price for ice-cream despite having identical costs. (30%) d) Calculate both
supermarkets’
profits at the prices you found in (c). (10%) e)
Now suppose that Sainsbury’s deviates to selling maple syrup at

, with Tesco still selling their maple syrup at

. Which types of consumers would
, given they were visiting the store anyway? Which types would
, given they were visiting the store anyway? (5%) f) Under the set-up of (e), how far from
Sainsbury’s is the high
-value shopper who is just indifferent between buying from Sai
?
how far from Sainsbury’s is the low
-value
consumer that is just indifferent between buying from Sainsbury’s and buying from Tesco?

and

, not the solution found in (c). (5%) g) Under the set-up of (e), w
rite down an expression for each supermarket’s profits as a function of
prices. (Again, be careful to include the revenue from selling both ice-cream and maple syrup, to both high-value and low-value customers.) You do not need to attempt to maximise this expression for profits. (5%) h) A kindly mathematician tells you that when you hold

at the value you found in (c), under the set-up of (e), by choosing


optimally Sainsbury’s will make profits of
96
. They go on to tell you that if you repeat the exercise of parts (e) to (g) assuming that Tesco instead deviate to charging

for syrup, then with

held at the value you found in (c), and

chosen optimally, Tesco will make profits of
78
. Using your answer to part (d), and the calculations of this friendly mathematician, explain why both firms selling syrup at

must be a Nash equilibrium. (5%)
i) Now, suppose that Sainsbury’s decide to introduce a “Brand Match Guarantee”, as they have done
in real life. This is effectively a commitment to never price branded goods higher than Tesco does. Since both firms only sell non-branded maple syrup, here this promise just applies to the Haagen-Dazs ice-
cream. Given this guarantee (and assuming that Sainsbury’s can react instantly), what effect does
a cut
in Tesco’s
ice-cream price have
on Tesco’s profits? As a result
, assuming each firm still sells maple syrup at

, what price will each firm set for ice-cream in equilibrium? What are profits? (20%)
BONUS QUESTIONS IF YOU HAVE SPARE TIME: YOUR MARK CANNOT GO OVER 100% SCORES GIVEN HERE ARE ONLY ILLUSTRATIVE, AND EVEN A PERFECT ANSWER MAY ATTRACT EITHER HIGHER OR LOWER POINTS AT MY DISCRETION. THUS I DO NOT ADVISE YOU TO SKIP PARTS ABOVE IN ORDER TO ANSWER THESE PARTS.
j) Find the Nash equilibrium for maple syrup prices in the set-up of part (i). (5%) k) Prove the results of the friendly mathematician from part (h). (20%)