Question

3.1 Horizontal and Vertical Differentiation There are only two shops selling sweet-and-sour soup in this area. For sim plicity, we set their marginal cost of production to zero. As it happens, one shop (named "Won-Ton" and indexed by l) is located at point, while the other shop (named "Too-Chow" and indexed by 2) is located at point 1. Everyday, each inhabitant of the street may consume at most one bowl of sweet-and-sour soup, bought either from Won-Ton or from Too-Chow. The price per bowl of the two shops are respectively denoted by Pi and P2. The net utility for a consumer located at on the interva 10.1 is given by ( - { r- )- P i f consumer buys at Won-Ton (1 - 1) -P2 if consumer buys at Too-Chow if consumer does not buy. where it is assumed that bowl of soup is large enough so that every consumer buys one 1. Before 1993 and the installation of the Mid-Levels escalators, walking up the street was much more painful than walking down. This is translated by the following assumptions () = tx and (1-x) = (t + 1)(1-r) with t,T> 0. 1.1 Derive the identity of the consumer who is indifferent between the two shops. 1.2 Compute the equilibrium prices and profits of the two shops 1.3 Show that Too-Chow's profits increase if walking up the street be comes more costly for consumers, that is if increases (eg, because the temperature has risen). Explain the intuition behind this result. 2 After 1993, the Mid-Levels escalators made going up and down equally painful for consumers. However, consumers had to pay a fixed feef (in- dependent of distance) to use the escalators. This is translated by the following assumptions: (I) = trand (1-1) = (1-1) + f with f>0. 2.1 Derive the identity of the consumer who is indifferent between the two shops. 2.2 Compute the equilibrium prices and profits of the two shops. 23 Express the condition in terms off and t) under which the previ- ons answers are valid (ie the condition for Too-Chow to set a price above its zero marginal cost). 2.4 Show that Two-Chow's profits increase if taking the escalator be comes less expensive, that is if f decreases. Explain the intuition behind this result and contrast with your answer at (1.3).

Answer 1

1.1

1. the horizontal differentiate refers that the distinction of the product cannot evlaute through quality. With very minimal additional cost , always producer intent to caputre the new consumer. As it tend to provide same cost at equlibrium and lack of relationship with quality ,
2. the consumers of the both the shops are indifferent.

1.2 -

1. Two firms producing identical products.
2. Each firm has constant marginal cost , c=0.
3. Equllibrium price is =p1=p2=c
4. Hence, Both firms amke nominal profit.

1.3-

1. Too-chow profits increased, as the price discrimination occured, here the seller has taken some part of consumer surplus and economic profit to increase the price based on his choice of consumer willingness to pay. Equation can be =r2 = MC>1 , hence TR always more.