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Perfect substitutes

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Consumers often have difficulty distinguishing brand-name products from cheap knockoffs, especially when making purchases over the web. This raises interesting questions about pricing and consumer behavior.

a. Suppose that customers can distinguish between brand name products and their knockoffs and do not view brand name products and their knockoffs as imperfect substitutes; some consumers want to purchase only the brand name while others are unwilling to pay the prices charges by the brand name and are happy with a low-price knockoff. Does the presence of knockoffs in the market harm the brand name producers? Explain why or why not.

b. Suppose that customers cannot distinguish between brand name products and their knockoffs when making the purchase over the internet and do not view brand name products and their knockoffs as imperfect substitutes; some consumers want to purchase only the brand name while others are unwilling to pay the prices charges by the brand name and are happy with a low-price knockoff. Does the presence of knockoffs in the market harm the brand name producers? Explain why or why not.

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Solution Preview

a) DO NOT view brand name as IMPERFECT substitutes = view as perfect substitute.

Brand name and cheap knockoff are viewed as perfect substitute and consumers can distinguish between the two.

In this case the presence of knockoffs in the market will harm brand name producers because consumers will substitute the knockoffs for the brand name. They are indifferent ...

Solution Summary

If consumers can distinguish between the brand name products and their perfect substitute knockoff products, they will buy the cheaper knockoffs. The demand for the brand name will be "zero". However, if consumers cannot distinguish between the two, the demand will be reduced but not to "zero". Some people will still buy the brand names accidentally.

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A production function has 2 inputs - labor and capital. Both are perfect substitutes. Existing technology permits 1 machine to do the work of 3 workers. The firm wants to produce 100 units of output. Suppose the price of capital is $700 per machine per week. What combination of inputs will the firm use if each worker is paid $300 per week? What combination of inputs will the firm use if each worker is paid $225 per week? What is the elasticity of labor demand as the wage falls from $300 to $225?

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