Question

Consider Firm 1, which has a monopoly in market A. It is merely one of many perfect competitors in market B. That is, it prices at marginal cost in B and makes zero economic profits in that market. Therefore, the only economic profit it makes is in the A market. We refer to this as “independent pricing”.

Some consumers value both A and B (call them AB customers). Others value only B (call them B-only customers).

Firm 1 would like to increase its total profit (over both A and B) and is considering a tying arrangement. That is, it will tell consumers: “if you want to buy any A from me, you must buy all of your B from me, too.”

If it does this, it will lose all of its B-only customers, because they can all switch to a rival seller of B firm and pay only marginal cost. But it may be able to keep its AB customers, as described in the online lecture of May 5, in the video clip that I made and in the uploaded notes.

a. Assume that the demand curve for A is given by: QA = 200 -2PA and that the AB demand curve in the market for B is given by: QB = 150 – 2PB. Assume that marginal cost is $1 in both markets. Calculate the monopoly prices on both markets.

b. At these prices, will the AB customers be willing to pay the monopoly price of B, or will they all decide to leave Firm 1 and get B at a price of $1? (Note: Because of the tying arrangement, any AB customer that buys B from a rival is not allowed to buy any A.) Prove your answer numerically.

c. Is Firm 1 better off with the tying arrangement than with independent pricing?

Answer 1

Market B (for AB) MR2=MC & 75.86=1 b = 74 Pb = 75-74 Pb = $38 16 At these prices, the AB customers will leave firm ol and will get B at a price of $1. The prices of 8 are less than the monopoly price. So consumers will prefer B to manimize Cowwer Surplus pays $38 bot to firm on then Quantity Dended, 86= 150-3822 24 In morket B Quand Demanded = 50-2 11118 1415741 Consumer will preger market &