Question

Two competing firms make identical products with unlimited capacity. In addition, each firm can choose to sell a repair contract that goes along with each product sold. Both firms have the same manufacturing costs: product costs $0.50 per unit to produce, and each repair contract sold costs its seller $0.10.

The market consists of 100 buyers each of whom have a reserve price of $3.00 for one product. However, not all buyers value the repair contract in the same way. The reservation price of half of the buyers for the service contract is $0.05 and for the other half, it is $0.85. Given prices are posted at the same time, by both the firms, buyers will make the purchase that maximizes their consumer surplus. (If buyers in any one market segment are indifferent between the two firms, half of them go to one firm and half go to the other firm.) Each buyer is interested in at most one product and at most one repair contract.

1. Consider a scenario where each firm sells both products and repair contracts separately and buyers can choose to buy none, one, or both products. What prices would each firm announce for widgets and repair contracts in equilibrium?

2. Consider a scenario where each firm sells both products and repair contracts as a bundle. Buyers can choose to buy the entire bundle or not, what prices would each firm announce for its bundle in an equilibrium?

3. If Firm 1 prices and sells the product and repair contracts separately while Firm 2 bundles the product and repair contracts, must firm 1 announce two prices, one fo the product and one for the repair contract? While firm 2 announces a single price for the bundle? Would profits of both firms in equilibrium be positive?

4. Of the three scenarios in the questions above, which is the most profitable?

Answer 1