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(Solved): Consider the following scenario: Suppose that Chemist Warehouse and Discount Drug Stores (one of S ...

Consider the following scenario: Suppose that Chemist Warehouse and Discount Drug Stores (one of Sigma's retail pharmacy brands) are the only two pharmacies in the (fictional) town of Woodheath Falls. Both pharmacies incur a constant marginal cost of


per unit of over-the-counter (OTC) medicine and fixed costs of


per month. Monthly demand in town for OTC medicine is given by


where Q represents thousands of units of medicine. Thus, if they were to act like a monopoly by coordinating their pricing to maximise their collective profits, their marginal revenue would be


However, suppose that if either pharmacy does not coordinate, it will charge


. Because the law does not allow them to collude on prices, each must decide which price to charge without knowing what the other will do. A) Using a payoff matrix, explain whether the pharmacies will coordinate to charge the monopoly price. Assume that if both charge the same price, they will each serve half the market. Otherwise, all consumers will buy from the firm with the lowest price. B) Now suppose that Chemist Warehouse and Sigma Healthcare merge. They decide to keep both pharmacies in Woodheath Falls open, but now they can explicitly coordinate their prices. At the same time, because both will be supplied by Sigma's distribution centre, their marginal cost falls to


, and their fixed cost falls to


. Explain whether and why consumer surplus will increase as a result of the merger. C) Identify one key assumption in the setup of the scenario in part B and explain how changing it could lead to a different impact on consumers. Justify with supporting evidence which scenario you believe to be more likely in the context of this merger.

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