Reference no: EM132421807
a: Tesco and Sainsbury's both sell hot cross buns at Easter. The products are produced in the same factory and the marginal cost of each pack of hot cross buns is 40 pence. Weekly market demand for hot cross buns is given by P = 420 - Q, where P is price and Q is quantity.
(a.i) Under Bertrand price competition, what price will the hot cross buns sell for?
(a.ii) What price will maximise the joint profits of the two firms?
(a.iii) If prices can be changed daily and Sainsbury's increases its price to this level, should Tesco follow suit? The daily discount rate is 0.25% and the current market price is 150 pence.
(a.iv) If there are 10 firms in the market all selling the same hot cross buns, would this change Tesco's strategic response to Sainsbury's price change? Briefly explain your answer
b) If Waitrose and Marks and Spencer enter the hot cross bun market with differentiated products, what effect will this have on price competition? Briefly explain your answer.
c) Customers can order their hot cross buns in advance for delivery at Easter. If Sainsbury's and Tesco agree to pay a rebate to customers who have placed an order, if they sell the hot cross buns at a lower price in store between the order date and delivery date, what is this an example of? How does this facilitate cooperative pricing?
d) Explain the difference between a firm's horizontal and vertical boundaries.
e) There is a small café which currently only serves hot and cold drinks. The café is contemplating diversifying its product range by introducing a selection of cakes and biscuits. The café owner is unsure whether to invest in upgrading the kitchen, so that the cakes and biscuits can be made on site, or whether to purchase the products from an independent bakery. Explain to the café owner the advantages and disadvantages of investing in the kitchen. What strategy would you suggest the café owner should follow?
f) If the decision is made to upgrade the kitchen, the café owner has the choice of making just biscuits (X), just cakes (Y), or both biscuits and cakes. The cost of the investment to make cakes is £12,000 or for an additional £3,000 the kitchen can also make biscuits. The £3,000 additional investment to make cakes and biscuits is only available if the cafe has first paid the £12,000 to make cakes. The cost of the investment in the kitchen, if the cafe does not make cakes, is £8,000. The cost of producing cakes is £0.25 per cake and the cost of producing biscuits is £0.05 per biscuit. If the expected quantity of cakes and biscuits per year are 80,000 and 120,000 respectively, should the café make both cakes and biscuits? Briefly explain your answer.
g) Is limit pricing an example of a relative barrier to entry or an absolute barrier to entry. Briefly explain.
h) Consider an industry consisting of an incumbent (M) and a potential entrant (E). Each year, market demand for this industry is given by P = 750 - (qM + qE), where P is price and q is quantity. In the first year, only the incumbent manufacturer has the technology to produce the cars, but in the second year the entrant has the option of entering the market. For both firms, there are non-recoverable fixed costs of £3,000 each year and constant marginal costs of £120 per unit.
(h.i) Use an extensive form game to find the incumbent firm's optimal strategy.
(h.ii) Is limit pricing a credible entry deterrence mechanism? If not, under what conditions can limit pricing pose a credible threat?