Question 5You negotiate with a retailer over a contract according to which the retailer would buy alarge fraction of your current production for next year. The retailer is perfectly informed aboutconsumer demand, but you do not know whether demand is high or low. You only know thatthe probability for high demand is 80%. If demand is high, the retailer's profit is £5 millionminus what he pays to you according to your contract. If demand is low, the retailer's profitis £3 million minus what he pays to you. Your costs of producing the output specified in thecontract are £1 million. You can make sequential offers for the retailer's total payment foryou to deliver a fixed quantity of your production.As you know that your competitor is also seeking a similar contract with this retailer, and theretailer can only supply one firm due to limited shelf space, you know that you can onlymake at most two offers. If your first offer is rejected, the retailer will strike the deal with yourcompetitor with 50% probability (which rules out that you will get a deal with the retailer fornext year), and if your second offer is rejected, the retailer will sign the contract with yourcompetitor for sure. That contract with your competitor will eam the retailer £1 million profitnext year under either realisation of consumer demand.Determine your optimal bargaining strategy (i.e., your optimal first and second offer) byfollowing the steps below:(a) Suppose you design your bargaining strategy such that the retailer may find it optimalto accept either of your offers, depending on consumer demand ("screening"). Forwhich level of consumer demand would you want the retailer to accept your first offer,and for which your second offer?(b) Formulate all participation and incentive compatibility constraints.(c) What is your optimal "screening" bargaining strategy and your expected profit whenplaying this strategy?(d) Can you do any better using a "non-screening" strategy in which the retailer acceptsyour first offer for sure (independent of consumer demand)?

If demand is high, the retailer would be willing to pay more for your product. Therefore, you would…

Determine your optimal bargaining strategy (i.e., your optimal first and second offer) by following the steps below: (a) Suppose you design your bargaining strategy such that the retailer may find it optimal to accept either of your offers, depending on consumer demand ("screening"). For which level of consumer demand would you want the retailer to accept your first offer, and for which your second offer? (b) Formulate all participation and incentive compatibility constraints. (c) What is your optimal "screening" bargaining strategy and your expected profit when playing this strategy? (d) Can you do any better using a "non-screening strategy in which the retailer accepts your first offer for sure (independent of consumer demand)?

Determine your optimal bargaining strategy (i.e., your optimal first and second offer) by following the steps below: (a) Suppose you design your bargaining strategy such that the retailer may find it optimal to accept either of your offers, depending on consumer demand ("screening"). For which level of consumer demand would you want the retailer to accept your first offer, and for which your second offer? (b) Formulate all participation and incentive compatibility constraints. (c) What is your optimal "screening" bargaining strategy and your expected profit when playing this strategy? (d) Can you do any better using a "non-screening strategy in which the retailer accepts your first offer for sure (independent of consumer demand)?

Brief Principles of Macroeconomics (MindTap Course List)

8th Edition

ISBN:9781337091985

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter9: The Basic Tools Of Finance

Section: Chapter Questions

Problem 9PA

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