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The market for taxi services in a Midwestern town is monopolized by Firm 1
The market for taxi services in a Midwestern town is monopolized by Firm 1. Currently, any taxiservices firm must purchase a $40,000 “medallion†from the city in order to offer its services. Apotential entrant (Firm 2) is considering entering the market. Since entry would adversely affectFirm 1’s profits, the owner of Firm 1 is planning to call her friend (the mayor) to request that thecity change the medallion fee by $F thousand. The extensive form representation of the relevantissues is summarized in the accompanying graph (all payoffs are in thousands of dollars andinclude the current medallion fee of $40,000). Notice that when F > 0, the medallion fee isincreased and profits decline; when F
Expert Solution
a. What are firm 1’s profits if it does not call to change the fee (that is if it opts for a strategy of maintaining the status quo)? b. How much will firm 1 earn if it convinces the mayor to decrease the medallion fee by $40,000 (F = -$40) so that the medallion fee is entirely eliminated? c. How much will firm 1 earn if it convinces the mayor to increase the medallion fee by $300,000 (F = $300)? d. Determine the change in the medallion fee that maximizes firm 1’s profits. e. Do you think it will be politically feasible for the manager of firm 1 to implement the change in (d)? Explain. Answer: (a) When the firm 1 (the principal mover) doesn't require the change, firm 2 has two choices to exercise: enter and make a profit of $200 thousand or not enter and make a profit of $0. Being the profit-maximizing firm, firm 2 would decide to enter and make a profit of $200 thousand. This demonstrates under this circumstance, firm 1 would make a profit of $300 thousand. That implies, the firm 1's profit is $300 thousand in the event that it doesn't call to change the fee. (b) When the firm 1 (the principal mover) requires the change of fee by (- $40,000), firm 2 has two choices to exercise: enter and make a profit of $240 thousand or not enter and make a profit of $0. Being the profit-maximizing firm, firm 2 would decide to enter and make a profit of $240 thousand. This shows under this circumstance, the firm 1 would make a profit of $340 thousand
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