Industrial Economics (Econ3400) Week 5 August 21, 2008 Room 323, Bldg 3 Semester 2, 2008 Instructor: Dr Shino Takayama

Summary of Chapter 3 The advantages from being large arise from economies of scale and economies of scope. The three advantages of using spot markets to source inputs are efficient adaptation. Holdup problem. How to construct the optimal incentive contract in a simple setting.

Agenda for Week 5 Returning HW1 Sample MDT and Last Year s MDT Entry Barriers Durable Goods Monopoly Coase Conjecture Strategic Consumer

Entry Barriers Government Restriction on Entry Natural Monopoly Source of Revenue Redistribute Rents Intellectual Property Rights Structural Characteristics Economies of Scale Sunk Expenditures of the Entrant Absolute Cost Advantages

Durable Goods Monopoly A durable consumer good is a good which provides a stream of sustained consumption services: it can be used more than once. Two complications for a monopolist The existence of second-hand markets Intertemporal decision of consumers

Coase Conjecture Durability and expectations might substantially reduce or eliminate the market power of a monopolist supplier of a durable good. Competitive Supply vs. Monopoly Supply The durable good monopolist has an incentive to practice intertemporal price discrimination. She could increase her profits by decreasing prices over time.

Strategic Consumer Any implications for consumer behavior? The consumers have an incentive to delay purchasing if he anticipates that the monopolist will try and lower prices in the future. The cost of waiting for consumers is that they do not get any surplus in the first period. Whether waiting is worthwhile for consumers depends on the surplus differential and the discount factor δ.

The Effect of Expectations on Intertemporal Price Discrimination Consider a durable goods monopolist with two units of a durable good. There are only two consumers and they differ by their willingness to pay for the durable good. The reservation price for the consumer with the high willingness to pay for the services of the durable is 15. The reservation price for the other individual is 10.

The profit-maximizing prices ? The market for the durable good only lasts two periods. In each period the monopolist sets a price and the consumers decide whether to purchase or not. Suppose that the discount factor for the monopolist and both consumers is the same and equal to δ. Find the profit- maximizing prices for the monopolist.

Selling vs. Leasing by a Durable Goods Monopolist A durable goods monopolist can produce at zero marginal cost. If r t is the rental or lease charge consumers pay per period, then the demand curve per period for services from the durable good is: r t = Q t, where t=1,2 and Q t equals the aggregate quantity of the durable good supplied at time t. Suppose that the discount factor for both consumers and the monopolist is one.

Well ask the following questions. What is the optimal rental rate for a monopolist that only leases? What are the optimal prices for a monopolist that only sells, but is able to commit to its second-period price? What is the optimal price path for a monopolist that only sells, but is not able to commit to its second-period price? What is the relative profitability of these three alternatives?

Pacman Economics Suppose now that the willingness to pay of the high type is 30 and the one of the low type is 10. Consider the following decision rules: The monopolist sets her price at period t equal to the highest reservation price of any consumer that has not purchased prior to t. (= Pacman Strategy) Consumers elect to buy as soon as the price is less than or equal to their reservation prices.