Bertrand Complements

Analysis.
 What are complements?
• Two firms each choose a price.
• Total price was the sum of the two prices.
• Demand was set by the total price.
• What on earth fits this story?
– Computer and screen.
– Computer and operating system.
– Shoes and shoelaces.
– Plane ticket and airport use.
 Krugman, NY times
• Who is Krugman?
• Krugman has lately been known for his
anti-Bush columns.
• Would he be, in favor, of breaking up a
monopolist such as Microsoft?
• In his column “MICROSOFT: WHAT
NEXT?” written in April 2000. He says the
following.
 What next?
• Baron Wilhelm von Gates was the lord of two
castles along the Rhine.
• From these castles he was able to demand
money from all the travellers who passed by.
• This made him wealthy, but also much disliked.
Eventually the Holy Roman Emperor split up the
Gates domain and give one to the Baron’s
nephew.
• But the results of this breakup were not quite
what the emperor's legal department had
promised.
 Price Competition with
complements.
• Take the demand=15-p, and mc=3 of the
monopolist in the experiment.
• The optimal price for him to charge is 9.
• Let us say that instead of a monopolist there are
two separate companies.
– For instance, one selling Windows and the other
Office.
• The marginal cost of either is now 1.5. Why?
• The demand is now 15-(p1+p2). Why?
 What is the equilibrium?
• Firm 1 chooses p1 to max (p1-1.5)(15-p1-
p2)
• Firm 2 chooses p2 to max (p2-1.5)(15-p1-
p2)
• p1=(13.5-p2)/2+1.5
• p2=(13.5-p1)/2+1.5
• Solving yields p1=p2=5.5.
 Who wins?
• Do the shareholders gain?
– Profit with the monopolist was 36.
– Profit with either firm is (p1-1.5)(15-p1-
p2)=(5.5-1.5)(15-5.5-5.5)=4*4=16
– Combined profit is 32.
• Do the users gain?
– Well the price WAS 9. Now it is 11 for both!!
 Returning to Krugman
• Travellers complained that things had gotten even worse.
• They faced two different robber barons, but were paying
more for each trip.
• Moreover, the combined income of the baron and his
nephew was less than the baron alone before.
• But this diminished revenue was the result not of lower tolls
but of reduced business.
• Before the breakup, von Gates had an incentive to exercise
restraint in his extortion: better to keep the tolls low enough
that river commerce was not impeded.
• Any restraint on his part would simply give his nephew an
opportunity to raise his own demands -- and his nephew
made the same calculation.
• So their combined tolls became too high even for their own
good.
• The ill-considered imperial response only made things
worse, punishing not just the baron but everyone else.
 Someone paid attention to
Krugman for once.
• Sept. 2001. The US Department of Justice
has announced that it will no longer push
to have software giant Microsoft broken
up.
 Homework
• There is a very Beersheva to Haifa train line. Travellers
either go between
– Haifa and Tel Aviv with demand 12-p
– Tel Aviv and Beersheva 12-p
– Haifa and Beersheva. 18-p
• Say it is all owned by one profit maximizing monopolist
with marginal cost of zero. For simplicity assume that the
monopolist must set the price of the Haifa-Beersheva
route equal to the sum of the other two. What would he
charge for all three routes?
• Now say the government thinks it needs to add
competition to the rail industry. It divides things into two
companies. One takes care of the Haifa-Tel Aviv route
and the other the Tel Aviv-Beersheva route. The price of
the combined trip is the sum of the other two.
• What are the new prices?
• Who wins and who loses?