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# ECO3041: Industrial Organisation.

(Mock) End of term test
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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 𝑣𝐻𝑆 or 𝑣𝐿𝑀 (rather than any other price), and why Tesco will price it at either 𝑣𝐻𝑇 or 𝑣𝐿𝑀 , (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 𝑣𝐿𝑀 . 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. You should find that Sainsbury’s sell ice-cream at £
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and Tesco sell it at

£ 4. Explain intuitively why Sainsbury’s is charging a higher price for ice-cream despite having identical costs. d) Calculate both supermarkets’ profits at the prices you found in (c). (30%) (10%)

e) Now suppose that Sainsbury’s deviates to selling maple syrup at 𝑣𝐻𝑆 , with Tesco still selling their maple syrup at 𝑣𝐿𝑀 . Which types of consumers would buy maple syrup from Sainsbury’s, given they were visiting the store anyway? Which types would buy maple syrup from Tesco’s, 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 Sainsbury’s and buying from Tesco? how far from Sainsbury’s is the low-value consumer that is just indifferent between buying from Sainsbury’s and buying from Tesco? Your answers should be a function of 𝑝𝑆𝐼 and 𝑝𝑇𝐼 , not the solution found in (c). (5%) g) Under the set-up of (e), write 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 𝑝𝑇𝐼 at the value you found in (c), under the set-up of (e), by choosing 𝑝𝑆𝐼 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 𝑣𝐻𝑇 for syrup, then with 𝑝𝑆𝐼 held at the value you found in (c), and 𝑝𝑇𝐼 chosen optimally, Tesco will make profits of
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Using your answer to part (d), and the calculations of this friendly mathematician, (5%)

explain why both firms selling syrup at 𝑣𝐿𝑀 must be a Nash equilibrium.

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 𝑣𝐿𝑀 , what price will each firm set for ice-cream in equilibrium? What are profits? (20%)

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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). k) Prove the results of the friendly mathematician from part (h). (10%) (40%)

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