CHAPTER 36: Information Technology
TRUE/FALSE
1. Network externalities are a special kind of externality in which people care about the number of other
people who consume the good.
2. For a good with network externalities, the number of people who are willing to buy a unit of the good
is uniquely determined by the price.
3. Copyright protection discourages the production of new software.
4. If the probability that a firm is caught making illegal copies of software increases with the number of
copies that the firm makes, then the larger the fine assessed for copying, the smaller will be the
number of copies made by each software-copying firm.
5. Economic theory suggests that the existence of a used-book market lowers the profits of publishers
below what they would be if every reader had to buy a new copy.
6. Video marketers and publishers are more likely to profit from allowing rentals of their products, the
higher the ratio of cost of production of originals to the transaction cost of rentals.
7. Intel produces the overwhelming majority of computer central processing units (CPUs) that run the
Microsoft Windows operating system. Systems competition reasoning would suggest that Intel could
only benefit from an outcome of the Microsoft antitrust case that is unfavorable to Microsoft.
8. Systems competition reasoning would suggest that when setting prices of its operating systems,
Microsoft need not consider the profitability of PC manufacturers who purchase Microsoft Windows
to install on their PCs.
MULTIPLE CHOICE
1. If the demand curve for the DoorKnobs operating system is related to perceived market share s and
actual market share t by the equation p = 144s(1 − x), then in the long run, the highest price at which
DoorKnobs would maintain a market share of 4/6 would be
a.
$48.
b.
$41.60.
c.
$32.
d.
$28.80.
e.
$38.40.
2. If the demand curve for the DoorKnobs operating system is related to perceived market share s and
actual market share t by the equation p = 98s(1 − x), then in the long run, the highest price at which
DoorKnobs would maintain a market share of 6/7 would be
a.
$18.
b.
$15.60.
c.
$10.80.
d.
$12.
e.
$14.40.
3. If the demand curve for the DoorKnobs operating system is related to perceived market share s and
actual market share t by the equation p = 147s(1 − x), then in the long run, the highest price at which
DoorKnobs would maintain a market share of 4/7 would be
a.
$36.
b.
$46.80.
c.
$54.
d.
$32.40.
e.
$43.20.
4. Professor Kremepuff has published a new textbook. This book will be used in classes for two years, at
which time it will be replaced by a new edition. The publisher charges a price of $p1 in the first year
and $p2 in the second year. After the first year, bookstores buy back copies from students for $p2/2 and
resell them to students in the second year for $p2. (Students are indifferent between new and used
copies.) The cost to a student in the first year of owning the book for a year is therefore $(p1 − p2/2). In
the first year of publication, the number of students willing to pay $v to own the book for a year is
60,000 − 1,000v. The number of students taking the course in the first year who are willing to pay at
least $w to keep the book for reference rather than resell it is 60,000 − 5,000w. In the second
year, the number of students who have not previously taken the course and are willing to pay at least
$p for a copy of the book is 50,000 − 1,000p. If the publisher sets a price of $p1 in the first year and
$p2 in the second year, with p1 B3 p2, then the total number of copies that the publisher sells over two
years will be equal to
a.
110,000 − 1,000(p1 + p2/2).
b.
120,000 − 1,000(p1 − p2/2).
c.
120,000 − 3,000p2.
d.
120,000 − 1,000p1 − 1,000p2.
e.
110,000 − 1,500p2.
5. Professor Kremepuff has published a new textbook. This book will be used in classes for two years, at
which time it will be replaced by a new edition. The publisher charges a price of $p1 in the first year
and $p2 in the second year. After the first year, bookstores buy back copies from students for $ p2/2
and resell them to students in the second year for $p2. (Students are indifferent between new and used
copies.) The cost to a student in the first year of owning the book for a year is therefore $(p1 − p2/2). In
the first year of publication, the number of students willing to pay $v to own the book for a year is
70,000 − 1,000v. The number of students taking the course in the first year who are willing to pay at
least $w to keep the book for reference rather than resell it is 70,000 − 5,000w. In the second
year, the number of students who have not previously taken the course and are willing to pay at least
$p for a copy of the book is 60,000 − 1,000p. If the publisher sets a price of $p1 in the first year and
$p2 in the second year, with p1 B3 p2, then the total number of copies that the publisher sells over two
years will be equal to
a.
130,000 − 1,000(p1 + p2/2).
b.
140,000 − 1,000(p1 − p2/2).
c.
140,000 − 1,000p1 − 1,000p2.
d.
140,000 − 3,000p2.
e.
130,000 − 1,500p2.
6. Professor Kremepuff has published a new textbook. This book will be used in classes for two years, at
which time it will be replaced by a new edition. The publisher charges a price of $p1 in the first year
and $p2 in the second year. After the first year, bookstores buy back copies from students for $p2/2 and
resell them to students in the second year for $p2. (Students are indifferent between new and used
copies.) The cost to a student in the first year of owning the book for a year is therefore $(p1 − p2/2). In
the first year of publication, the number of students willing to pay $v to own the book for a year is
40,000 − 1,000v. The number of students taking the course in the first year who are willing to pay at
least $w to keep the book for reference rather than resell it is 40,000 − 5,000w. In the second year, the
number of students who have not previously taken the course and are willing to pay at least $p for a
copy of the book is 30,000 − 1,000p. If the publisher sets a price of $p1 in the first year and $p2 in the
second year, with p1 B3 p2, then the total number of copies that the publisher sells over two years will
be equal to
a.
80,000 − 3,000p2.
b.
80,000 − 1,000(p1 − p2/2).
c.
80,000 − 1,000p1 − 1,000p2.
d.
70,000 − 1,000(p1 + p2/2).
e.
70,000 − 1,500p2.
7. A group of 9 consumers are trying to decide whether to connect to a new communications network.
Consumer 1 is of type 1, consumer 2 of type 2, consumer 3 of type 3, and so on. Each consumer’s
willingness to pay to belong to the network is proportional to the number of consumers who belong.
Where k is the number of consumers who belong, the willingness to pay of a type n consumer is equal
to k times n. What is the highest price at which 7 consumers could all connect to the network and
either make a profit or at least break even?
a.
$23
b.
$19
c.
$18
d.
$26
e.
$21
8. A group of 13 consumers are trying to decide whether to connect to a new communications network.
Consumer 1 is of type 1, consumer 2 of type 2, consumer 3 of type 3, and so on. Each consumer’s
willingness to pay to belong to the network is proportional to the number of consumers who belong.
Where k is the number of consumers who belong, the willingness to pay of a type n consumer is equal
to k times n. What is the highest price at which 9 consumers could all connect to the network and
either make a profit or at least break even?
a.
$47
b.
$50
c.
$43
d.
$42
e.
$45
9. A group of 9 consumers are trying to decide whether to connect to a new communications network.
Consumer 1 is of type 1, consumer 2 of type 2, consumer 3 of type 3, and so on. Each consumer’s
willingness to pay to belong to the network is proportional to the number of consumers who belong.
Where k is the number of consumers who belong, the willingness to pay of a type n consumer is equal
to k times n. What is the highest price at which 7 consumers could all connect to the network and
either make a profit or at least break even?
a.
$23
b.
$26
c.
$18
d.
$19
e.
$21
10. Banks have started offering electronic bill pay for free. This decision can best be explained as
a.
matching free services provided by competitor banks to win over new customers.
b.
increasing switching costs. Customers would have to set up electronic bill pay again at
their new bank.
c.
banks wanting to enhance their reputation for good service.
d.
banks reducing their costs of paper check processing.
e.
a fad or novelty.
11. Given the many components of a personal computer that are perfect complements, which of the
following factors would NOT contribute to increased profit for Microsoft as a supplier of operating
systems?
a.
A single corporation (Intel) controls the overwhelming majority of the market for CPU
chips.
b.
Hardware has largely become a commodity.
c.
The market for DRAM memory chips is highly competitive.
d.
Microsoft Office is frequently bundled with PCs.
e.
More than one of the above answers is correct.
12. Why might a profit-maximizing firm producing a new product with network externalities want to give
its product away for free?
a.
To lock customers in then raise prices at a later date.
b.
Although this practice loses money, it can get the firm valuable publicity.
c.
By building market share, the product becomes much more valuable and the firm can
make money by offering a premium version of the product for sale.
d.
The product becomes a more valuable place to advertise if it doesn’t cost anything.
e.
A profit-maximizing firm would never give its product away for free.
13. Our old friend Edmund Stench from Chapter 2 has now grown up and is in the business of producing
punk rock DVDs. He must choose between selling his DVDs to final consumers, or selling his DVDs
to firms that will rent them to the public. Which of the following factors would make rentals more
attractive than sales?
a.
A large number of people interested in viewing punk rock DVDs
b.
Large transaction costs of renting
c.
high cost of making DVDs relative to transaction costs of renting
d.
A small number of people interested in viewing punk rock DVDs
e.
High fixed costs of production
PROBLEM
1. List three examples of products for which there are significant network externalities. Explain why you
believe network externalities are present in each case.
2. For a good with network externalities, draw a diagram showing the relation between the number of
units sold and the willingness to pay of demanders. Find a price at which there are two stable and one
unstable equilibrium quantities. Label these equilibria and explain why the unstable equilibrium is
unstable.
3. One proposed remedy for the Microsoft antitrust case is to break Microsoft into three equal parts and
strictly prohibit any coordination between the parts. The three mini-Microsoft’s would then compete
with one another in both the operating system and applications markets. From a Systems Competition
perspective, comment on how this proposed settlement might eventually affect consumers.
