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The question requires detailed mathematics with the respective diagrams. Deep Knowledge in industrial organization and microeconomics is necessary
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Question 3
Consider the market for a (fictional) brand of car, Carro. We will analyze this market in
Isolation (neglecting its Interactions with markets for other cars).
Carros are produced by a single producer. Carro Motors. The production technology
exhibits constant returns to scale, at a marginal cost of CM = 2. There are no fixed costs.
Carro Motors sells all the cars It produces to two dealers, Carro East and Carro West,
who then sell the cars to consumers. The price that Carro Motors charges the dealers
Is PM. Both dealers pay the same price. Each dealer, however, is allowed to charge a
different price to consumers.
Both dealars sell only Carro cars, and neither of the two has any costs other than the
cost of buying the cars from the manufacturer. Because Carro East and Carro West sell
the same physical product, customers regard buying from one dealer as a substitute
for buying from the other dealer. However, because the dealers are located in differ-
ent geographical areas, the substitutes are Imperfect. Therefore, the dealers face the
following demand functions:
9E = 8–3pe + Dwi
qw = 8–3pw+PE
where pe and pw are the prices of Carros at Carro East and Carro West, respectively.
and de and gw are the quantities sold at the two dealerships.
The dealers compete by simultaneously setting prices.
Please answer the following questions. Make sure that you explain all the steps of your
analysis and that you define any new notation that you use. You may assume that cars
are Infinitely divisible (this can be somewhat Justified by Interpreting the quantities as
shipments consisting of many cars).
(a) Compute the equilibrium prices, quantities, and profits when all three firms are in
dependent.
(14 marks)
(b) Suppose all three fims merge, forming a single entity. Carro Cars, which manufac-
tures the cars and sells them in both geographical areas (let qe and qw now be the
quantitles sold in the areas formerly served by Carro East and Carro West, respec-
tively). Compute the new equilibrium prices, quantitles, and profits.
(10 marks)
(C) Did the merger Increase or decrease total surplus? (Note: you do not need to com-
pute total surplus explicitly)
(5 marks)
(d) Now suppose that the final retail market becomes perfectly competitive. Would
there still be a benefit to vertical Integration?
(5 marks)
(Total 34 marks)
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