Week 5 Exercises
Analysis Questions
1. When Ticketmaster Corporation bought out its major competitor, Ticketron, it became a virtual monopoly in the computerized ticket service industry. Ticketmaster pays arenas millions of dollars for the right to sell tickets to events, often protecting monopoly power by having the first few hours of ticket sales - when popular events may sell out, and when the best seats are sure to go - to itself. A spokesman for Ticketmaster estimates that company sells 85 to 90 percent of the tickets for its 1600 clients. Ticketmaster's raised the average service charge per ticket from about $1.00. to about $2.50 per ticket, and the service charge can go higher with steep demand, up to $6.50 to see a popular rock group.
Question: Does the fact that Tickemaster raised its average price tell us anything about the relationship between MC and MR at a $1 price?
2. If you like Disneyland (and who doesn't) then southern California was the place to live. Periodically the Walt Disney Company offered a "resident salute" which allowed adult visitors who could prove they lived in southern California entrance to the theme park for 25% off the regular price. Disney is using a classic case of market segmentation, in an attempt to increase profit during a sagging market.
Question. How does this scheme increase the profit made at Disneyland?
3. Airlines in financial trouble brought a new reason for canceling airline flights, according to some travel experts, economics. While mechanical and staffing difficulties, weather and other such factors still cause most cancellations, airlines began canceling flights that did not pay.
The new attitude seems to have come from the slump in travel that started with the Persian Gulf crisis in 1990 and continues today. Airlines sometimes cancel flights because passenger loads were down.
Question. Most airlines are losing money, but continue flying. Since they continue flying, what must be the relationship between price and average cost? Does this improve or hurt profits?
4. The rental car industry has many factors that point towards oligopoly. For short term use, few people worry about the make of the car they drive. The main choice has to do with the car size, price, and minor amenities. Four large firms dominate the industry in the 100 largest airports - Hertz, Avis, Budget and National - and some smaller firms like Alamo and Dollar compete on the fringe.
One thing we see frequently is that if one rental car company holds a sale in selected cities, other companies match the low price. But most companies resist increasing prices, and in fact, often absorb, at least for a while, any cost increases.
Question. With what model of competition is this behavior consistent? What could cause all firms to increase the prices they charge? Explain.
TECHNICAL QUESTIONS
1. Suppose we have a firm which faces a total cost of TC=0.5Q2-10Q+200 and a demand curve Q=1500-50P, which can be rewritten P=30-Q/50.
a) Find the profit maximizing and revenue maximizing output and price for this firm. (Hint: TR=Total revenue = P*Q. Substitute for P to find TR as a function of Q. Profit = TR-TC. Maximize profit by taking the derivative with respect to Q and setting equal to zero, and maximize revenue by taking the derivative of TR with respect to Q and setting equal to 0).
b) If the firm is assessed a license fee of 50, what would we expect to happen to its output under each goal?
2. Periodically the Federal Deposit Insurance Corporation, the federal agency which insures deposits in commercial banks, increased its premium. This fee essentially increased the cost per unit of output, shifting up the marginal and average variable cost curves by the amount of the increase. Most banks felt the competitive nature of the market for banking forced them to absorb the fee increase in the short run. But a bank analyst for Dain Bosworth claimed that eventually all banks pass fee increases on to customers. Explain why both positions are consistent with what is expected in perfect competition.
3. Suppose a local town wants to raise more tax revenues. It is considering two taxes. One tax would be imposed on local cable television, which has a monopoly. The other tax is on gasoline, which is sold in a competitive market environment. An economist testifies that consumers would pay all the tax on gasoline, but the cable television company would share part of that tax. But gasoline station owners say their competitive market would force them to absorb the tax, while the monopoly cable television company plans to just pass the tax on to its customers. Who is correct, and why? (HINT: Think about profit maximization rules, and the relationship between P, AC and MC in long run equilibrium under both market structures.)4. Compare the incidence (who pays) and burden (total welfare or profit loss) of a per unit tax in monopolistic competition, and oligopoly. If the firm is assessed with a tax, figure how much is passed on, and the effect on the number and size of firms in the market.
6. We see frequent price changes in the airline industry. Why would this behavior be inconsistent with the kinked demand curve model of oligopoly? With which model is it most consistent? Explain.