Reference no: EM132356125

Case Study: Government and Business

Please address the following case study relating to Microsoft Windows.

Section 1. Efficiency
For the purposes of this problem set, you will take the role of a manager at Microsoft in the 2000's. You act as a monopolist in selling your Microsoft Windows operating system for which you have substantial fixed costs and low and constant marginal costs.

In about one paragraph, describe how and why Microsoft fails to achieve allocative efficiency in selling its Windows operating system under these assumptions.

In about one paragraph, describe how and why Microsoft fails to achieve productive efficiency in selling its Windows operating system under these assumptions.

Sections 2. Market Power Interventions

Computer programs are similar to natural monopolies; they have large fixed costs to design but have a small (and stable) marginal cost for selling additional copies. For the following equations, quantities are measured in 100's of millions and fixedcosts and profits are scaled accordingly (but this has no impact on working the problem). Suppose that Microsoft Windows has the inverse demand function:

p = 370-20Q

and the cost function:

C = 900+10Q

Suppose that we wanted this market to be socially efficient (assuming that Microsoft wouldn't shutdown if it were to produce at the socially efficient level). Find the socially optimal production. What is the resulting deadweight loss?

Find the profit-maximizing output and price for Microsoft sales of Windows as a single-price monopolist. What is the resulting deadweight loss?

Suppose that we want to be as efficient as possible while still allowing Microsoft to break-even on its sale of Windows. Find the ideal price (and output) under a regulated monopoly. (Hint: this probably involves a step with the quadratic equation.) What is the resulting deadweight loss?

Sections 3. Externalities

Having a common operating system for many of the world's computer-users greatly reduces learning costs for students and training costs for firms because users are generally familiar with how the operating system works. This can be represented as a positive network externality. (Such an externality might be incorporated into demand, but not necessarily in its entirety.) Suppose that the positive externality can be quantified as:

External Benefit = 5Q²

Demand continues to be:

p = 370-20Q

and Microsoft's costs continue to be:

C = 900+10Q

a) Recognize that marginal social benefit is the marginal private benefit (demand) plus the marginal external benefit and the marginal social costs are just the marginal costs of production and distribution for the firm. And identify the socially optimal level of Production.

b) Assume that Microsoft uses the profit-maximizing output. Identify the deadweight loss in this market that results from the combination of Microsoft's monopoly pricing and the lack of capitalizing on the positive externality.

c) Identify a subsidy (opposite of a tax) that will, in general, cause Microsoft to internalize the positive network externality. (Subsidizing a monopolist probably isn't politically viable; but, what if it were?) Suppose that Microsoft doesn't attempt to optimize its subsidy and continues to produce the monopolist output. Don't worry about getting a socially ideal result; just let Microsoft reap the full benefit of its sales. This should not be a per unit subsidy.

Sections 4. Non-excludability

In one to two paragraphs explain how pirated copies of Microsoft Windows relate to non-excludable goods. Be sure to indicate what we would expect to happen to the operating system industry if pirating becomes pervasive.

You may assume that developing and providing security for operating systems is costly and there are no secondary ways to recoup the cost of development.