Assignment 1

Due date: 10th April, 2024 at 10 am

The marks allotted to each question are indicated in brackets alongside.

Question 1. Suppose consumers differ in the way they value quality, with their valuation
of quality captured by θ ∼ U [0, 1]. Thus, consumers with a high θ value improvements in
quality more strongly. Further, suppose there are two firm, with firm 1 producing a product
of quality q1 and firm 2 producing a product of quality q2 , where q1 < q2 . The prices of the
two products are p1 and p2 respectively. Suppose the firms have the same constant marginal
cost of production, c, that is independent of quality. We assume that all consumers buy the
product from one of the two firms.

i. Derive the expression for the profit of the two firms as a function of the prices and
qualities of the products. [5]

ii. Derive the equilibrium pricing strategies of the two firms. Explain how they vary with
changes in q1 , q2 . [6]

iii. Derive the profits of the two firms at the equilibrium. Which firm earns higher profits? [4]

Question 2. Suppose two groups of agents, group a and group b, interact through a plat-
form which charges a fixed fee, Ma and Mb , respectively from the agents of the two groups for
access to its services. Suppose there are na group a agents and nb group b agents with each
agent belonging to group a deriveing a benefit of $3 per group b agent and each agent belong-
ing to group b deriving a benefit of $8 per group a agent. Further, suppose va , vb is the surplus
of a group a and group b agent, respectively, and that na = 1 + va and nb = 1 + vb . Finally,
suppose the platform incurs a cost of ca per group a agent and a cost of cb per group b agent.

i. Derive the surplus enjoyed by the agents of the two groups at the equilibrium. [10]

ii. Derive the fee paid by the agents of the two groups. Which group pays a higher mem-
bership fee? Explain. [5]