Industrial Organization

Please see the attachment.

Econ3319 (2013): Assn1_Monopoly
Ruth Forsdyke

Due: Wed. Oct. 2nd in class. Please see outline for late regulations.

Question 1: This question should alert you to the important information to be found in
company annual reports (which will be of use for your projects). You will also become
aware that annual reports do not transparently aggregate over products for multi-product
firms. This makes it difficult to get precise estimates of revenues, costs and profits for
specific products. Nonetheless, we can get some idea of what Microsoft’s spends money
on and what brings in revenues. Some of the cost and revenue elements may be
surprising!

Look at Microsoft’s Annual report for 2012 available at:
http://www.microsoft.com/investor/reports/ar12/financial-review/income-
statements/index.html

a) Is it possible to find out how much profits, revenues and costs accrued to the Microsoft
Word product? Explain.
b) For the year 2012, for Microsoft as a whole, find the following:

i) total revenue
ii) total profits (net income)
iii) total costs

c) What are the main divisions of Microsoft? Identify ONE product in each division.
Which division brings in the most revenue? What is % of total revenue is generated by
this division. Make a rough estimate of the revenue generated by Microsoft Office (see
“operating segments” tab).
d) What is the single biggest category of investments (as of June 30th, 2012)?
e) How much does Microsoft claim it was taxed at in 2012? (see “discussion and analysis
tab”).
f) How much was spent on the following cost categories as a % of total revenue? (see
“discussion and analysis tab”).

i) research and development (R&D)
ii) sales and marketing.
iii) general and administrative.
iv) dividends and interest income.

g) To get an idea of labour costs, see tab on employees. How many employees were
hired in each class of occupation?
h) Briefly describe the antitrust case relating to the Novell Word Perfect word processing
product (see note 17 on contingencies). Some other websites with information are here:
http://blackfootjournal.com/wordperfect-tale-provides-good-lessons/
http://arstechnica.com/tech-policy/2012/07/antitrust-ruling-says-microsoft-didnt-kill-
wordperfect-novell-did/
i) Identify an acquisition, which occurred in 2012 (see tab on subsequent event, note 22).
j) Explain an element of Microsoft’s vertical structure and also horizontal structure. Is it
a conglomerate?
k) Identify ONE fixed cost and ONE variable cost of Microsoft.

Question 2:
For full marks, please use graph paper and a ruler. Label your graphs carefully being
sure to include units. Give your graph a title. Set up all mathematical solutions carefully
using short sentences to guide the reader and short concluding sentences stating what you
found. Make your graph big as you will need to put a lot of labels on it. Colors help to
make it easier to read.

Assume that Microsoft has a near monopoly in word- processing, so we will model MS
Word as if it is a pure monopoly. Also assume that Microsoft is an ordinary
monopolist selling Word at the same price to all consumers (not true, it price
discriminates by selling at a lower price to students for example), and that it does not
bundle the product (not true, MS Word is purchased as part of MS Office).

Assume that marginal costs are constant at $10/unit.
Assume that total fixed costs are equal to $7 billion/y.

Assume the demand for word- processing software is:

QD(P) = $600 – 10*P/3
Prices are in $/unit and quantities are in millions of units/ year.

a) Rearrange the demand curve to get the inverse demand equation.
b) Find the total revenue and then take the derivative to get the marginal revenue
equation.
c) On a graph plot the following:

i) Demand curve.
ii) Marginal revenue.
iii) Marginal cost.
iv) Average fixed cost.
v) Average variable cost.
vi) Average cost.
vii) Profit maximizing quantity.
viii) Profit maximizing price.

The following table may help:
Q Inverse

Demand
MR(Q) MC AFC(Q) AVC AC(Q)

d) Write down the profit equation and then take the first derivative to find the first order
condition. Solve for the profit maximizing price and quantity.

e) Take the second derivative of the profit equation to find the second order necessary
condition in order to check to see if this is a maximum.
f) Find total profits and total variable profits and label on your graph.
g) Label the following on your graph.

xi) Total Revenue.
xi) Total Fixed Costs.
xi) Total Variable Costs.
xii) Total Costs.

h) Use your graph to roughly find the minimum scale at which Microsoft could
profitably operate. Label on your graph and explain briefly.
* If you want to solve for this, you will need the quadratic equation. This would be a
good exercise but you do not have to do it. You can find quadratic equation solvers on
the web.
i) Use your graph to find the maximum scale at which Microsoft could profitably
operate. Label on your graph and explain briefly.
j) Is this market for word processors allocatively efficient? Briefly explain.
j) Suppose you are a regulator. Identify the marginal cost and average cost price
ceilings. Would your recommend that Microsoft be regulated with either of these price
ceilings? If not, suggest an alternative. Be sure to consider dynamic efficiency in your
answer. Hint: You will need to use the quadratic equation to solve for the AC price
ceiling.
j) Briefly discuss possible reasons why Microsoft has a near monopoly in this product.
You may wish to consider entry barriers in your answer. These are reasonable
hypothesize.