Industrial Organization - Term Paper Example

Assignment: Industrial organization Question1 (a) Since the information is symmetric, the buyer will only be willing to buy iff P is equivalent to their satisfaction ѲB, if the seller decides to sell he does it as long as the price is equal or greater than the satisfaction and otherwise remains with price p if he does not sell. Thus seller sets price such that P≥ ѲS. There would be no tradeoff between the buyer and seller since prices are set higher than the buyer’s satisfaction.(b) The information is asymmetric, the buyer assumes that the seller is rational and quality is uniformly distributed.

The seller sets P˃ѲS, buyer holds its belief while the seller makes no sells if P˂ѲS.(c) The buyer only buys at P˂ѲB but the seller is at take it or live and only willing to sell at P≥ѲS.so the expected utility of the buyer will be at only P≥U, thus the utility will be u=ѲB if he buys the product and 0 if he does not. As long the seller sets its price P≥ѲS, there would be no clearing price and no trade takes place between the two as the buyers are not willing to spend more.(d) High prices reduces public demand hence little trade takes place between sellers and buyers {Tirole Jean, 1988}.

In real life sellers actually set prices so as to compensate their production cost equivalent to MC and does not reduce it since they would make a loss.Question 2.(a) Probability of buying high quality=4/5 and the probability of buying low quality=1/5. Since the product quality are observable, the willingness to buy high quality is 4/5 while the willingness to buy low quality is 1/5.(b) (i)As the firm provides warranty they incur extra cost of w. thus expected utilities becomes, for high quality ½[10×4/5+0]=4.

Expected utility for low quality, ½[1/5×4+0]=0.4(Tirole & Jean, 1988). Since the expected utility for high quality is higher than the low quality and the information is unknown, consumers will go for higher quality foregoing the low quality. If low quality offers warranty they will make no sales thus their warranty is 0 while setting their price at c/PL=0.8=p. (ii) Expected cost= c/Pr of high quality= c/1.25≥p, since marginal cost= price. But the firm incurs extra cost as the possibility is more than one, hence warranty= 1.25PH-1.(c) If firms cannot offer warranty and the consumers are rational, they will go for high quality products since information is believed to be asymmetric.

Consumers will buy products that will last and sure will work. (d) Profits of b is less than the profits of c. since consumers are assumed to be rational in c, there would be more sales as more high quality products would be sold as opposed to when the information is unknown in b.(e) In case of two firms, a firm with higher warranty would make more sales than the other and since they are competing in prices, the firm with lower price will be more productive and thus will determine the equilibrium.

When there is no warranties, firms would be only competing in prices and quantity determined by the market(Tirole &Jean, 1988).High quality production will have more influence in the market and will constitute an equilibrium at MC=P.Question 3.Time periods for consumer protection should be set as products tend to depreciate over time as they are used by consumers (Tirole & Jean, 1988). Providing the warranties over the excess periods would mean repairing worn out products and the firm would incur unnecessary expenses.

Work cited Tirole, Jean. The theory of industrial organization. Cambridge, Mass.: MIT Press, 1988. Print.