Question

5. Suppose that there are two pizzerias located at either end of a one mile long Main Street. Along Main Street there is potential market of 4000 customers, uniformly spread out on the street. Each consumer is willing to pay a maximum of $21 for a pizza at their door step. To travel a distance d from the consumer’s location the consumer incurs a cost of $2 per mile. To go to a pizzeria the consumer incurs the cost traveling there and traveling back. Each firm has a unit cost, c = $4, of making a pizza. a. (5 points) Consider first the case of full or perfect information where consumers know about these restaurant and their prices. What will price will each pizzeria set? What market share will each restaurant have at these prices? What profit will they each earn? b. (5 points) Now suppose that consumers only know about one of these restaurants, say pizzeria 1. No one is aware of pizzeria 2. What price will pizzeria 1 set? c. ( 5 points) Now what happens if through advertising X percent of the population knows only about pizzeria 1 whereas (1-X) percent of the population knows about the two pizzerias. What effect will this have on the prices for pizzas set by the two restaurants and how do prices change as X decreases? (You are not being asked to solve for a specific answer but to write about what you think will happen to prices and why.)

Answer 1

If through advertising, X percent of the population knows only about Pizzeria1 and (1-X) percent of the population knows about the two Pizzerias then since the percent of people knowing about Pizzeria1 is more as compared to people knowing about Pizzeria2. This is so because people knowing about pizzeria1 is included in both X as well as (1-X) percent of population. Thus the demand for Pizzeria1 would be obviously higher. Thus taking the advantage of this higher demand, Pizzeria1 may set its price higher than Pizzeria2.

Now, if X decreases then Pizzeria1 faces strong competition with Pizzeria2, since people are familiar with both the Pizzeria and thus they have an equal demand for both Pizzeria1 and Pizzeria2, as a result, Pizzeria1 reduces its price to the price level of Pizzeria2 and thus the market of Pizzeria faces a perfect competition