Section 1. Efficiency (pages 656-664)
For the purposes of this problem set, you will take the role of a manager at Microsoft in the 2000’s. You act as a monopolist in selling your Microsoft Windows operating system for which you have substantial fixed costs and low and constant marginal costs.
- In about one paragraph, describe how and why Microsoft fails to achieve allocative efficiency in selling its Windows operating system under these assumptions.
- In about one paragraph, describe how and why Microsoft fails to achieve productive efficiency in selling its Windows operating system under these assumptions.
Section 2. Market Power Interventions (pages 664-673)
Computer programs are similar to natural monopolies; they have large fixed costs to design but have a small (and stable) marginal cost for selling additional copies. For the following equations, quantities are measured in 100’s of millions and dollar amounts are scaled accordingly (but this has no impact on working the problem). Suppose that Microsoft Windows has the inverse demand function:
and the cost function:
- Suppose that we wanted this market to be socially efficient (assuming that Microsoft wouldn’t shutdown if it were to produce at the socially efficient level). Find the socially optimal production. What is the resulting deadweight loss?
- Find the profit-maximizing output and price for Microsoft sales of Windows as a single-pricemonopolist. What is the resulting deadweight loss?
- Suppose that we want to be as efficient as possible while still allowing Microsoft to break-evenon its sale of Windows. Find the ideal price (and output) under a regulated monopoly. What isthe resulting deadweight loss?
Section 3. Externalities (pages 673-684)
Having a common operating system for many of the world’s computer-users greatly reduces
learning costs for students and training costs for firms because users are generally familiar with
how the operating system works. This can be represented as a positive network externality.
(Such an externality might be incorporated into demand, but not necessarily in its entirety.)
Suppose that the positive externality can be quantified as:
Demand continues to be:
= 490 − 20
and Microsoft’s costs continue to be:
= 460 + 10
- Recognize that marginal social benefit is the direct marginal benefit of the product (demand)plus the marginal external benefit, and identify the socially optimal level of Production.
- Assume that Microsoft uses the profit-maximizing output. Identify the deadweight loss in thismarket that results from the combination of Microsoft’s monopoly pricing and the lack ofcapitalizing on the positive externality.
- Identify a subsidy (opposite of a tax) that will, in general, cause Microsoft to internalize thepositive network externality. (Subsidizing a monopolist probably isn’t politically viable; but,what if it were?) Don’t worry about getting a socially ideal result; just let Microsoft reap thefull benefit of its sales. This should not be a per unit subsidy; we will do that next.
- Identify the per unit subsidy that will cause Microsoft to produce the socially optimal level ofproduction. Remember that this subsidy needs to offset both the positive externality and theinefficiency created by Microsoft’s monopoly pricing. Supposing that Microsoft produces theoptimal output given this subsidy, what is the cost of the subsidy (to the government)?
Section 4. Non-excludability (pages 684-687)
- In one to two paragraphs explain how pirated copies of Microsoft Windows relate to nonexcludablegoods. Be sure to indicate what we would expect to happen to the operatingsystem industry if pirating becomes pervasive. You may assume that developing and providingsecurity for operating systems is costly and there are no secondary ways to recoup the cost ofdevelopment.