You submitted this quiz on Mon 19 Aug :29 PM PDT (UTC -0700). You got a score of 8.83 out of You can attempt again, if you'd like.

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1 Feedback End-of-week quiz Week 6 You submitted this quiz on Mon 19 Aug :29 PM PDT (UTC -0700). You got a score of 8.83 out of You can attempt again, if you'd like. Welcome to the sixth and final end-of-week quiz! As in the last five weeks, we put some questions together to help you review the week's topics. If you don't know the answers to some of the questions right away: No worries, just give it a try! After the quiz we will provide detailed explanations for each question. Alternatively, you will find support from your fellow students and the teaching staff in the discussion forums. As usual, you have three attempts to take this quiz and your best score will be stored. Nevertheless, you don't have to take the quiz three times. Please take care: We designed this quiz in a way that the questions change from attempt to attempt. Good luck and have fun! Question 1 Which of the following assumptions lead to the unrealistic prediction of the Betrand Paradox: Your Answer Score Explanation The firms compete repeatedly on the market. The market is perfectly transparent One assumption of the Bertrand model is that prices are set only once. In reality, firms compete repeatedly on the market and set prices more than once. Under certain circumstances, this enables the firms to collude and e.g. coordinate their prices. This enables the firms to achieve positive profits One assumption of the Bertrand Paradox is that the market is perfectly transparent, e.g. the consumers always know the prices of all firms. As soon as one firm lowers its price, all consumers will know this instantly and buy from this firm only. This strengthens price competition. 1/10

2 In reality, markets are often imperfectly transparent and not all consumers can observe the prices of all firms. Hence, undercutting prices has only a marginal effect on some consumers. This weakens competition since firms are less eager on lowering prices. This subsequently enables firms to achieve positive profits. The consumers have different tastes. The consumers are infinitely price elastic On assumption of the Bertrand model is that the firms products are identical. If the consumers have different tastes, this enables the firms in the market to differentiate their products. Each firm can focus on a certain niche of the market and tailor its product to the taste in this niche. This reduces competition and enables the firms to achieve positive profits One assumption of the Bertrand Paradox is that consumers are infinitely price elastic. This means that all consumers just care about prices and switch to the firm that charges the lowest price. This makes it very attractive for firms to charge prices that are just a bit lower than the ones of their competitors, because they will get all consumers. In reality, consumers experience some costs associated with switching to another seller. Imagine a consumer is part of a loyalty programme at the initial seller. When switching to another seller who charges lower prices, the consumer has to give up all the privileges related to the initial seller. Maybe it may not be worth for the consumer to switch even if the other seller charges a much lower price. In this context, switching costs such as loyalty programmes lower competition and enable firms to achieve positive profits. Total / Question 2 According to the Bertrand Paradox, two firms in the same market reach a Nash Equilibrium where both firms charge a price 2/10

3 equal to their costs. equal to the monopoly price. that is adjusted to the current demand. that is set by the government. Total / Question Explanation In the Bertrand Paradox, two firms in the same market set prices equal to their costs. Given the assumptions of the Bertrand Paradox (identical products, game played once, market fully transparent, infinite price elasticity of demand, no capacity constraints), each firm has an incentive to charge a price that is slightly lower than the price of the other company. The firms undercut each other s prices till they end up in a situation in which they both charge prices equal to marginal costs. Question 3 Imagine two firms are active in the same market. What can these firms do to avoid the Bertrand trap? They can reduce the costs of production. They can try to interact repeatedly and make sure that there is no clear endpoint If both firms lower their production costs, this has no influence on the competition in the market One assumption of the Bertrand model is that the firms interact only once in the market. The firms can try to ensure that they interact repeatedly. If there is no clear endpoint to the repetition game, this enables the firms to collude and e.g. coordinate their prices. This way, they can achieve positive profits. They can limit their production 0.25 One assumption of the Bertrand Paradox is that each firm has enough capacity to serve the whole market. Hence, 3/10

4 capacity so that they cannot serve the whole market. the firms have high incentives to set prices below the ones of their competitors because they will subsequently sell to all consumers in the market. If the firms limit their production capacity, they have no incentive to induce a price war over the complete demand. This lowers competition and enables firms to achieve positive profits. They can make their prices more visible so that every consumer knows about the prices of all firms If all consumers know the prices of both firms (perfect market transparency), all consumers will instantly switch to the firm that charges the lower prices. This makes it very attractive for the firms to charge lower prices than their competitors. In the worst case, they will end up undercutting each other till prices equal costs. Total 0.50 / Question 4 Two products A and B are vertically differentiated if given equal prices, every consumer would choose product A over product B (or product B over product A). given equal prices, some consumers would choose product A whereas others would choose product B. Total / Question Explanation Given vertical product differentiation, product A (B) has a better quality than product B (A). Every consumer prefers product A (B) over product B (A) some consumers are willing to pay a reasonably high price for product A, and the other consumers have capacity constraints and want to purchase product B for fair prices. 4/10

5 Question 5 Imagine you are thinking about buying a new smartphone. At the retailing store, the sales person shows you the latest models from Apple, Samsung and HTC. Some smartphones use the new LTE transmission technology that allows you to surf the web much faster. Others are using the conventional 3G technology with lower transmission rates. Which of the following statements are true? The different brands represent vertical product differentiation. The different transmission technologies represent vertical product differentiation. The smartphones are neither horizontally nor vertically differentiated It is reasonable to assume that some consumers prefer Apple mobiles, whereas others like the design of the Samsung mobiles more, etc. There is no clear ranking over the brands. Hence, the different brands represent horizontal product differentiation Every consumer prefers the new technology with the high transmission rates over the old technology with the low transmission rates. It is just that some consumers are willing to pay a higher price for the new technology than others. Hence, the different transmission technologies represent vertical product differentiation The smartphones are horizontally (different brands) and vertically (different transmission technologies) differentiated. Total / Question 6 Coca Cola and Pepsi both sell bottled cola soft drinks. Their cola soft drinks have the same quality and price but taste differently. In the Hotelling Bertrand model, the difference in taste 5/10

6 of Coca Cola and Pepsi is represented by the different locations of the sellers along the beach. the discomfort from walking of a consumer. the position of a consumer along the beach. Total / Question Explanation In the Hotelling Bertrand model, the difference in taste of Coca Cola and Pepsi is represented by the different locations of the sellers along the beach. In analogy, the more different Coca Cola and Pepsi are, the further away the sellers in the Hotelling Bertrand model are. Question 7 Burger King and McDonald s sell burgers of the same price and quality but of different taste. Some consumers prefer burgers from Burger King, others like McDonald s more than Burger King. According to the Hotelling Bertrand model, which of the following events have (ceteris paribus) a positive influence on the profits of the two fast food restaurants? Your Answer Score Explanation Burger King changes the recipe of its burgers. They now taste very different from the McDonald s burgers This represents an increase in the horizontal product differentiation. The burgers become less similar. Hence, the fast food restaurants now have difficulties to steal more consumers from each other by lowering prices. This decreases the incentives for price reductions. The fast food restaurants can realize higher profits. The 0.33 If the consumers become more extreme in their preferences, this 6/10

7 Burger King is represented in the Hotelling Bertrand model by an increase in fans the discomfort of walking. This leads to a decrease in competition become which has a positive effect on the profits of the firms. more extreme In the fast food context, the Burger King fans experience now and are no more pain when eating a McDonald s burger than before. Hence longer McDonald s would have to lower its burger prices by a lot to willing to convince the Burger King fans to choose McDonald s rather than eat any Burger King. Such an extreme price reduction would cannibalize McDonald s McDonald s revenues from its loyal customers (because they burger at would also pay a much lower price even though they are willing to all. pay much more). Hence, McDonald s will most likely not lower prices and avoid a price war with Burger King. This decrease in competition has an additional positive effect on the profits of the two fast food restaurants. Suddenly, much less people dine at fast food restaurants If there are less people interested in fast food, the fast food restaurants compete more fiercely on the remaining consumers. Hence, price competition increases. This leads to a reduction of the profits of the restaurants. Total / Question 8 Imagine there are two companies offering the same kind of product: One firm is offering a low quality version and the other firm is offering a high quality version. Given this market structure, the firm offering low quality will never realize positive profits. can realize positive profits....most likely realizes higher profits than the firm offering high quality. 7/10

8 Total / Question Explanation It is reasonable to assume that there are - (A) some consumer that are willing to pay high prices for good quality - (B) some consumers with a strong preference for decent quality to affordable prices - (C) some consumers that are would buy both products. The two companies offer vertically differentiated products. Consumers A will always stick to the high end products and consumers B will always stick to the low end products. By lowering prices, the companies can only steal consumers C from each other. Since price reductions would cannibalize the revenues they make from their loyal consumers, the companies will most likely not end up in a price war over consumers C. Hence, they will end up in a situation with low competition in which both companies achieve positive profits. It is not necessarily true that the company offering lower quality can achieve higher profits than the company with quality products. You could imagine that that the high quality company can charge a higher price mark-up on costs than the low end company and hence achieve higher profits. Question 9 Imagine you are the owner of an ice cream stall at Marienplatz, the city centre of Munich. You are known for selling low quality vanilla ice cream to affordable prices. Next door opens a Häagen Dazs store that sells premium vanilla ice cream for high prices. Which of the following statements are true? You will end up in perfect competition because the ice creams are horizontally differentiated. Competition decreases (ceteris paribus) when there are many people who are 0.00 The ice creams are vertically differentiated: Häagen Dazs offers high quality ice cream and your ice cream has low quality Competition decreases with the degree of heterogeneity in terms of the consumers willingness to pay. The number of people with a high willingness to pay for good ice cream has as such a rather negative influence on competition. Think about the extreme case of all 8/10

9 willing to pay high consumers having a high willingness to pay for good ice prices for premium cream. In this case, you will try to increase your quality ice cream. (which drives costs up) and price and get closer to Häagen Dazs. This increases competition since you and Häagen Dazs are serving the same consumers and have both incentives to lower prices marginally in order to steal consumers from each other. The simpler and cheaper the Hägen Dazs ice cream, (ceteris paribus) the lower the competition The simpler and cheaper the Häagen Dazs ice cream, the more similar it is to your own product. If the products are very similar, consumers do not care about where to buy their ice cream but just buy from the supplier with the lower prices. This makes it attractive for you and Häagen Dazs to lower prices and steal customers from each other. In the worst case, you end up in perfect competition with prices that equal costs and zero profits. Total 0.67 / Question 10 Which of the following statements are true? The main idea of the differentiation strategy is to focus on a particular buyer group, product line or geographic market. A central element of the cost leadership strategy is minimizing costs in areas such as R&D, services, sales force and advertising. A differentiation strategy is easily compatible with low prices and high market shares Total 0.67 / 9/10

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