Suppose you work as an economic consultant in a company which is producing an in

Question

Suppose you work as an economic consultant in a company which is producing an intermediate good and has monopoly power (manufacturer). They use a retailer (who also is a monopolist) to sell their product, but they want to make sure if this is a good idea!!

a. Without presenting any mathematical argument to people in charge of hiring you, what would you suggest? How would you make a verbal argument to convince them that they need to follow your suggestion?

b. Now they hire you because they think your argument is valid. They want you to tell them how much extra profit they make if they follow your suggestion. For this they give you the demand function in the market: q = 10 2p and their marginal cost: MCm = 2 and the retailer’s marginal cost: MCr = 1. Retailer makes one unit of the final product out of every unit he buys from the manufacturer at a fixed marginal cost which is the same if the manufacturer retails herself. (you can think of this cost as packaging costs, transportation costs, etc).

c. How would consumers feel about your suggestion in terms of price and quantity?

Explanation / Answer

1. Using a different retailer(who is a monopolist) to sell your product shall not be a good thing as you do not have complete control over the product. If you could sell your product on your own, you will actually have direct control over market forces of demand and supply of your product. As the demand shall demand on price you charge, you are in complete control of the price, which otherwise was in control of the retailer. There shall also be a direct relationship b/w you and your customers which otherwise is not possible, which can be used to know the consumer behaviour more effectively and thus making you do better market research and make possible changes in the product as and when possible and necessary.

2. q = 10 -2p

Out of q, he actually sells = q/2

MCm = 2 which implies that for q/2 units TCm = q

MC1 =1, he makes 1 unit out of 2 units he buys from the manufacturer at a fixed MC

So he also makes q/2 units at a total cost of q/2 units.

(A). If firms do not sell itself, rather sell it to retailer to sell.

So profit to the firm = pq = 10-2p(p) - 2q = 10p - 2p2 - 2q

(b). If firm sell itself instead through retailer :

So profit of the firm = pq = (10-2p) (p) - 2q/2 = 10p - 2p2 - q

So profit in the case b is higher than the profit in case 1.

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