Question

(a) What impact will a producer – producer rivalry have on a good’s prices (increase or decrease)? Please explain

(b) What impact will a consumer – consumer rivalry have on a good’s prices (increase or

decrease)? Please explain.

(c) A bond pays $100 at the end of each year for five years, plus an additional $1,000 when the bond matures at the end of five years. What is the most you would be willing to pay for this bond if your opportunity cost of funds (interest rate) is 6 percent? Please show your calculations

Answer 1

(a): Producer- producer rivalry occurs when there are more than one producer in the industry and each of them wants to capture more of the market. Due to existence of rivalry, each of them would like to reduce some of price to attract consumers. This behavior leads to decrease in good price in equilibrium.

(b): Consumer- consumer rivalry occurs when there are more than one consumer in the market and each of them wants to buy good to gain utility. Due to existence of rivalry, each of them would like to pay more price to get the good. This behavior leads to increase in good price in equilibrium.

(c): Since interest rate is 6%, Present Value of stream of payments is:

$\frac{100}{1+0.06}+\frac{100}{(1+0.06)^{2}}+\frac{100}{(1+0.06)^{3}}+\frac{100}{(1+0.06)^{4}}+\frac{100+1000}{(1+0.06)^{5}} = 1168.49$

This implies the most the buyer should pay is 1168.49 because paying more than this can create loss.

Maximum willingness to pay = 1168.49