MECN 430
Homework 4 (Individual)
Winter 2017
1. After graduating from Kellogg, you land a job with the tech firm Lentil, a startup
company seeking to unseat Intel’s leadership in microprocessor industry in the long run,
and to supplant AMD as Intel’s main competitor in the short run. Lentil’s engineers have
just developed a new, fast computer chip, the Repentium. Your market research
colleagues tell you that there are two types of consumers potentially interested in the
Repentium: Power Users and Surfers. Power Users in particular desire the speed and
power of the Repentium chip, and each Power User is willing to pay $300 for 1 chip.
There are 500,000 Power Users. Meanwhile, Surfers are more casual about their
computing power, and so Surfers are only each willing to pay $125 for 1 chip. There are
1,000,000 Surfers. It costs $50 to make a chip.
a. What price do you recommend for the Repentium? How many chips will Lentil sell
at this price?
b. What are Lentil’s profits?
c. How much consumer surplus do the Power Users enjoy?
d. How much consumer surplus do the Surfers enjoy?
Upon realizing that Lentil’s profits, as computed above, would not generate enough cash
flow to keep the company afloat and develop newer products, you remembering a course
you took at Kellogg, and call a meeting with Lentil’s engineers. You ask them, “Is it
possible to add additional circuits to the Repentium, whose only function is to slow the
chip down and disable some of its most powerful features?” The engineers look at you as
if you’re crazy, but they tell you that it’s possible. Putting these additional circuits on a
chip will cost an additional $5 per chip. You tell them to go ahead and make a batch of
these slower chips, and name the new chip CeleryRoot. Obviously, the CeleryRoot is less
desirable to Power Users; they would each only be willing to pay $150 for one of these
chips. On the other hand, Surfers weren’t using the capabilities of the Repentium
anyhow; they’d each be willing to pay $125 for the CeleryRoot chip.
e. What price do you recommend for the new CeleryRoot chip?
f. What price do you recommend for the Repentium now?
g. Suppose that a consumer will choose the chip for which he gets the greatest consumer
surplus. What are Lentil’s profits now?
h. How much consumer surplus do the Power Users now enjoy?
i. How much consumer surplus do the Surfers now enjoy?
When you presented your pricing scheme at a meeting with the CEO, the marketing
director lauded you for creativity, but noted that according to their latest estimates, the
number of Surfers willing to purchase Lentil’s product is not 1,000,000 as thought earlier,
but as high as 1,500,000. How do your profit-maximizing prices change? Why?
2. Comcast has retained you to consult on its pricing for cable programming. Through
extensive market research, your team has identified two types of customers who
subscribe to Comcast cable; there are approximately 1,000,000 of each type in Comcast’s
Chicago service area. The values they place on different types of Comcast-provided
programming are as follows:
Type 1 Type 2 Network Television $11 $8 Sports and Special Interest ? $13 However, you’re uncertain about the value of Sports and Special Interest to Type 1
consumers. Part of your team has estimated this value to be $10; others believe that
estimate to be implausibly low, and have argued that it must be at least $14 and possibly
as high as $18. The assistant project manager of your team has just sent the group an
email instructing your team to spend another month gathering data to obtain a better
estimate of that unknown value and resolve the dispute, in order to provide Comcast with
clear recommendations. You can assume a MC of 0 for both network television and
sports & special interest.
a. What is the profit-maximizing price for network television (if sold separately)?
b. For the values suggested by the team (i.e., $10, $14, and $18), what is the profitmaximizing price for sports and special interest (if sold separately)?
c. For the values suggested by the team (i.e., $10, $14, and $18), what is the optimal
price for the bundle consisting of network television and sports & special interest?
You can assume that if a type is willing to pay $x for network television and $y for
sports & special interest, then it is willing to pay $x+$y for the bundle.
d. Based on the above, would you recommend that Comcast sell network television and
sports & special interest as a bundle? Can you offer Comcast a useful pricing strategy
today, despite the disagreement within your team? Here you need to consider only
pure bundling (not mixed bundling or tying).
3. After graduating from Kellogg, you land a terrific job as a brand manager for General
Mills, where you have been given responsibility for its new Sriracha Frosted Flakes
cereal. Through extensive market research, you have identified two types of customer for
the new cereal. Type 1 individuals would pay at most $4 for the cereal, while Type 2
individuals value the cereal at $3. The two types also differ in the value of their time and
perspective on coupon use. For Type 1 individuals, the time, hassle and embarrassment of
using a coupon costs them the equivalent of $1.25, while for Type 2 individuals, finding
and using a coupon is costless. The marginal cost of a box of cereal is $2.50.
What price for the cereal do you recommend? Do you recommend that General Mills
offer a coupon? If so, how large a coupon do you recommend?
4. Redo the previous question, but now assume that everyone has the same cost ($1.25) in
time and hassle of using a coupon.