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# BU EC 385 - Midterm #1 Solutions 1

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Answers: Not necessarily. The restriction will break a vertical integrated firm into separate upstream and downstream components. This may actually worsen the well-being of the consumer because the downstream firm will buy at an inflated monopoly price when it would buy at marginal cost if it were vertically integrated.Boston University Professor Todd IdsonEC385 Economics of Sports Summer 2016, Midterm #1 SolutionsInstructions: Answer all questions below in your blue books (be sure to show all of your calculations). Please label all parts of your diagrams and draw them large enough so that all aspects can be readily assessed. Each question is worth 25 points.1. Suppose that each team in a league has a demand curve for generic advertising (a league-wide nonteam–specific campaign) equal to Q = 1,000 - 10p. If there are 25 teams in the league, and ads cost \$200 each, how many ads will the teams want to purchase as a group? Illustrate your result graphically.2. Would fans be better off if government prevented media outlets such as Disney or local cable companies from owning pro sports teams? Be sure to fully articulate your answer and to illustrate your answer diagrammatically.Answers: Not necessarily. The restriction will break a vertical integrated firm into separate upstream and downstream components. This may actually worsen the well-being of the consumer because the downstream firm will buy at an inflated monopoly price when it would buy at marginal cost if it were vertically integrated.3. Suppose the typical Buffalo Bills fan has the following demand curve for Bills football games: P = 120 - 10G where G is the number of games the fans attends.(a) If the Bills want to sell the fan a ticket to all eight home games, what price must they charge? What are their revenues?Answer: If the Bills want to sell tickets to all 8 games by selling eight individual tickets, they have to set the price P = 120 - 10× 8 = 120 – 80 = \$40. This yields revenue of \$40 × 8 = \$320 from each fan.(b) Suppose the Bills have the chance to offer a season ticket that is good for all eight home games, a partial season ticket that is good for four home games, and tickets to individual games. What price should they charge? What is their revenue?Answer: If the Bills practice second degree price discrimination, they can effectively charge P = 120 – 10 × 1 = 120 - 10 = \$110 for single games, P = 110 + 100 + 90 + 80 = \$380 = \$95/ticket for a 4-game package, and P = 110 + 100 + 90 + 80 + 70 + 60 + 50 +40 = \$600 = \$75/ticket for an 8-game package. Revenues are clearly much higher for the price discriminating example than one where the team wishes to sell as many as 8 tickets to some fans but must sell tickets individually.4. Discuss the central issues raised in the Krautmann, Anthony and David J. Berri, “Can We FindIt at the Concessions? Understanding Price Elasticity in Professional Sports,” and their key theoretical results. Be sure to work out their analytic model in detail (not just describe in words their results).Answer (more than you need for full points): Many studies have shown that teams price their tickets in the inelastic range of demand, which implies that teams are not profit-maximizing. The authors attempt to explain these results by considering the complementarity between tickets sold and concessions.As you can see in the above figure, if teams price their tickets in the inelastic (elasticity is less than 1) range of demand, marginal revenue is less than zero. Note that profit- maximizing team should satisfy the condition of MR=MC. But, marginal cost cannot be negative, and it means that the team which price their tickets in the inelastic range of demand is not profit maximizing. Using the fact that marginal revenue for teams include both revenue from tickets andconcessions, they derived the relationship between the profit-maximizing price, , and the ticket-only price, .Model:Let the team’s demand for tickets be given by: ( i.e. )Then the ticket revenue is .Let the team’s total cost (TC) be given by: where is the marginal cost (MC) of admitting another fan into the stadium, andis the fixed costs of the team.Then, we can find the optimal quantity and price for ticket-only case as follow:PQDMRElasticity = 1Elasticity < 1Elasticity > 1Since , marginal revenue is also positive, and it means that profit maximizing team does not set ticket prices in the inelastic range of demand.Now, also consider concession revenues. i.e. total revenue is sum of ticket revenues and concession revenues.Let concession revenues be given by:where is the marginal revenue of concession.Then, total revenue is .Thus, margina revenue is Note that profit maximizing team satisfies the optimal condition of MR=MC, i.e.Rearranging above equation: If , then the profit-maximizing team can set the price such that (i.e. inthe inelastic range of demand). Moreover, if we assume that (i.e. marginal cost of admitting another fan into the stadium is zero), then the marginal revenue of ticket is always negative since is positive. i.e. profit-maximizing team set the price in the inelastic range of demand. Solving above equation for the profit-maximizing quantity and price, and , we get:As we can see above, the profit-maximizing price is less than the ticket only price since is positive. In other words, profit-maximizing teams can set their price in theinelastic range of demand if they also consider concession revenues as their total

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