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Dominant strategy/pricing

The Province of British Columbia decides to legalize marijuana.1 It does
so, however, under rather stringent conditions. First, it mandates that the
price be C$10 per ounce (the marginal cost per ounce-including provincial
taxes-to producers is C$3). Second, it restricts the business to two
firms BC Stone Age and Reefer Madness. Suppose that, annually, there
are ten million customers total at C$10/oz. Since we are talking about
Canadians, we know that they will be law-abiding and not buy from unlicensed
distributors (so there is no point in anyone else attempting to
enter this business). With typical over-reaction, the United States closes
the border between Washington and British Columbia, so there are no
American customers.
(a) Suppose that British Columbia limits the two companies' advertising.
In particular, for one week each year each company can run a radio
and tv ad campaign. The campaign costs C$3,000,000. If neither
firm runs a campaign or if both run a campaign, they each get half
the customers that year. If only one of the two runs a campaign,
it gets 75% of the customers that year (and the other firm gets the
remaining 25%. The two firms decide simultaneously whether or not
to mount a campaign. In this strategic interaction, do the firms have
a dominant strategy? If so, what is it?
(b) A person on the bc Marijuana Advertising Board offers to tip off
Reefer Madness if bc Stone Age will be running a campaign before
Reefer Madness must decide about mounting its own campaign. Is
this valuable information? How does your answer relate to part (a)?
(c) To make up for the tax revenue lost due to the elimination of American
tourism, British Columbia raises the tax on marijuana. Now
each firm's marginal cost is C$9. How does that change your answer
to (a) (if it does)?
(d) In 2008, Hillary Rodham Clinton becomes President and the Democrats
regain control of both houses of Congress. As a consequence,
the ban on Americans travelling to British Columbia is lifted (but
at the same time, the State of Washington is permitted to legalize
marijuana, so there is no change in demand for marijuana in British
Columbia). This, in turn, leads bc to reduce the tax, so marginal
cost returns to C$3. The province does, however, propose a ban on
marijuana advertising. Would Reefer Madness and bc Stone Age
favor or oppose such a ban? Why or why not?
(e) Dangers of Free Entry. Advertising is banned. British Columbia
does, however, relax the restriction on the number of firms that can
enter. Now any firm can enter provided it pays a C$1 million fee
per year. Assume that the firms in the marijuana business in British
Columbia divide the demand evenly among themselves. How many
firms sell marijuana annually in British Columbia? What is their
annual profit?

Solution Preview

The Province of British Columbia decides to legalize marijuana.1 It does
so, however, under rather stringent conditions. First, it mandates that the
price be C$10 per ounce (the marginal cost per ounce-including provincial
taxes-to producers is C$3). Second, it restricts the business to two
firms BC Stone Age and Reefer Madness. Suppose that, annually, there
are ten million customers total at C$10/oz. Since we are talking about
Canadians, we know that they will be law-abiding and not buy from unlicensed
distributors (so there is no point in anyone else attempting to
enter this business). With typical over-reaction, the United States closes
the border between Washington and British Columbia, so there are no
American customers.
(a) Suppose that British Columbia limits the two companies' advertising.
In particular, for one week each year each company can run a radio
and tv ad campaign. The campaign costs C$3,000,000. If neither
firm runs a campaign or if both run a campaign, they each get half
the customers that year. If only one of the two runs a campaign,
it gets 75% of the customers that year (and the other firm gets the
remaining 25%. The two firms decide simultaneously whether or not
to mount a campaign. In this strategic interaction, do the firms have
a dominant strategy? If so, what is it? ...

Solution Summary

Dominant strategy/pricing is assessed.

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