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You are an executive for Super Computer, Inc. (SC), which rents out supercomputers. SC receives a fixed rental payment per time period in exchange for the right to unlimited computing at a rate of P cents per second. SC has two types of potential customers of equal number鈥10 businesses and 10 academic institutions. Each business customer has the demand function Q = 10 - P, where Q is in millions of seconds per month; each academic institution has the demand Q = 8 - P. The marginal cost to SC of additional computing is 2 cents per second, regardless of volume.

  1. Suppose that you could separate business and academic customers. What rental fee and usage fee would you charge each group? What would be your profits?
  2. Suppose you were unable to keep the two types of customers separate and charged a zero rental fee. What usage fee would maximize your profits? What would be your profits?
  3. Suppose you set up one two-part tariff鈥攖hat is, you set one rental and one usage fee that both business and academic customers pay. What usage and rental fees would you set? What would be your profits? Explain why the price would not be equal to marginal cost.

Short Answer

Expert verified
  1. The academic customer's usage fee and rental fee will be 2 cents per second and $180,000 per month, respectively. Business customers' usage and rental fees will be 2 cents per second and $320,000 per month, respectively. The profit will be $5 million per month.
  2. The usage fee is 5.5 cents per second and 2.45 million per month.
  3. The usage fee will be 3 cents per second, and the rental fee will be $125,000 per month. The total profit will be 3.7 million per month. The price would not be equal to marginal cost as it will lower the profit.

Step by step solution

01

Explanation for part (a)

The consumer surplus of the academic customer is calculated below:

CS=0.568-2=0.566=18millioncentspermonth=$180,000permonth

The rental fee will be $180,000 per month, and the usage fee will be 2 cents per month. The total profit will be $1,800,000 per month.

The consumer surplus of the business customer is calculated below:

CS=0.5810-2=0.588=32millioncentspermonth=$320,000permonth

The rental fee will be $320,000 per month, and the usage fee will be 2 cents per month. The total profit will be $3,200,000 per month.

The total profit 5 million per month (= 3,200,000 + 1,800,000).

02

Explanation for part (b)

The total demand function will be the summation of the demand function of the total of both the customers. The total demand function will be:

Q = 1010 - P+ 108 - P= 100 - 10P + 80 - 10P= 180 - 20PP = 9 - 0.05Q

The profit-maximizing condition will be at the level where the marginal revenue is equal to the marginal cost.

MR = 9 - 0.1QMC = 2MR = MC9 - 0.1Q = 20.1Q = 7Q = 70millionsecondP = 9 - 0.0570= 9 - 3.5= 5.5centspersecond

The profit is calculated below:

=5.5-270=245millioncentspermonth=$2.45millionpermonth

The profit will be $2.45 million per month.

03

Explanation for part (c)

Under a two-part tariff and no price discrimination, the rental fee is set equal to the consumer surplus of the academic institution. The rental fee will be:

Rent = CSA= 0.58 -P*8 -P*= 0.58 -P*2

P* is the usage fee, QA is the total computer time used by ten academic customers, and QB is the total computer time used by ten business customers.

The total revenue and total cost curves will be:

TR =20Rent+QA+QBP*TC = 2QA+QB

The profit function will be:

=20Rent+QA+QBP*-2QA+QB=108-P*2+P*-2180-20P*诲蟺dP*=20p*-160+180-40p*+40=0-20p*+60=020p*=60p*=3centspersecond

The usage fee will be 3 cents per second; the rental fee will be 0.58-32=0.552=12.5millioncents=$125,000permonth.

The QA and QB will be:

QA=108-3=105=50millionsecondsQb=1010-3=107=70millionsecondsQ=50+70=120millionseconds

The profit will be,

=2012.5+1203-2120=250+360-240=370millioncents=$3.7millionpermonth

The profit is greater when the rental price is not zero; thus, the price cannot equal marginal cost, reducing the profit.

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Most popular questions from this chapter

Many retail video stores offer two alternative plans for renting films:

鈥 A two-part tariff: Pay an annual membership fee (e.g., \(40) and then pay a small fee for the daily rental of each film (e.g., \)2 per film per day).

鈥 A straight rental fee: Pay no membership fee, but pay a higher daily rental fee (e.g., $4 per film per day).

What is the logic behind the two-part tariff in this case? Why offer the customer a choice of two plans rather than simply a two-part tariff?

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P1 = 15 鈥 Q1 MR1 = 15 - 2Q1

P2 = 25 - 2Q2 MR2 = 25 - 4Q2

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Suppose that two competing firms, A and B, produce a homogeneous good. Both firms have a marginal cost of MC = \(50. Describe what would happen to output and price in each of the following situations if the firms are at (i) Cournot equilibrium, (ii) collusive equilibrium, and (iii) Bertrand equilibrium.

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Some years ago, an article appeared in the New York Times about IBM鈥檚 pricing policy. The previous day,IBM had announced major price cuts on most of itssmall and medium-sized computers. The article said:

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a. Provide a brief but clear argument in support of the claim that IBM should try 鈥渢o get its customers to purchase more and lease less.鈥

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