Macro & Micro economics
1.
a) What is the issue with “Double Marginalization”? What can be done to overcome the problems with double marginalization when firms are receiving inputs from input suppliers and attempting to innovate to produce differentiated products and even seeking patent on these products in order to dominate or even take the market?
b) Give us some perspective on how double marginalization issues might be resolved.
c) Does your solution coincide with the profit maximization solution of innovating and producing up to the point where marginal cost equal marginal revenue? Explain.
2) Suppose firms A and B are going head to head developing new products (innovation) and the projected net profits in $billions are given in the following normal form payoff matrix. Firm A’s payoff ($billions) for innovation, R&D, and production is given first in going from left to right.
Company B
Strategy >>>>
Low innovation, R&D, & production High innovation, low R&D & low production
Company A Low innovation, low R&D & low production 30, 10 10, 15
High innovation, high R&D & high production 20, 5 1, 2
What is the Nash equilibrium and explain what it means in terms of innovation, R&D, and production.
Is there a dominant solution, and if so, give us a description of this solution and the firm position in this innovation race.
3) Now suppose there is a strategy whereby Firm A can concentrate on the initial mover position in this race, that is, position itself to be first mover. So then we face a sequence of moves as given below.
a) Does concentration on being the first mover (in innovation, R&D, and production) play out favorable to Firm A, and is this position better than the simultaneous and probably similar approach represented in (2) above. {Remember payoff is at the end of this two stage sequential strategy outline — So, A moves first, and then B reacts. Payoff is given for A first in going from left to right.}.
b) Who gains and who may be loser in this innovation struggle between firms? Why such gains or losses? Explain.
4) Let’s go back to the strategy play outlined in (3) above. Suppose that the econometrician for both firms project the demand function for the output, Q, produced is related to own price, P, income, m and advertisement, AD, is Q = 0.2P-1.05m1.4AD0.4 . Calculate the estimated advertising budget that follows the “Proposition 11.1” recommendation on projecting the advertising-to-sales ratio for Firm 1 and Firm 2 with both the solution for problems 3 and 2 above.
5) Provide an explanation of the strategies for “Cross Subsidy” pricing and “psychological” pricing.