1

MegaStiff Corporation sells operating systems and applications for personal computers. A while back, it acquired a revolutionary new application that allows users to control the operation of any electronic device in their workplace or home from their computers. MegaStiff reengineered the application so that it would run exclusively on its proprietary operating system, Screens. Following extensive market research and beta testing, MegaStiff marketed the product, now called MSDoesEverything.

Initial market research showed that monthly demand for MSDoesEverything is Q_sum = 1,000,000 - 7000P. What price should MegaStiff charge for MSDoesEverything, given this residual demand schedule and zero marginal cost (probably not strictly accurate, but close enough for a first cut), to maximize contributions to overheads from this product? $71.43. How many units of MSDoesEverything does MegaStiff Corporation sell each month at this price? 500,000. What is its total revenue from MSDoesEverything sales?

$35.7M.

2. Further market analysis shows existing demand for MSDoesEverything is made up of the demand schedules of three distinct user groups: techies, who download MSDoesEverything from the web and install it themselves, technologically challenged residential users who purchase software in stores and rely on sales personnel to install it, and technologically challenged business owners who purchase software by subscription and rely on consultants to install and maintain it. The residual demand schedule for the techies is Q_t = 500,000 - 5000P and for the business owners it is Q_b = 200,000 - 500P. What is the residual demand schedule for technologically challenged residential users, Q_r= 300,000 - 1,500P. Assuming techies do not resell MSDoesEverything to technologically challenged residential users or businesses and residential users do not resell it to businesses, what prices should MegaStiff charge each of these groups for MSDoesEverything (again assume zero marginal cost)? $50, $100, $200. At those prices, how many units of MSDoesEverything will it sell per month to each of those groups and in total? 250,000, 150,000, 100,000, 500,000. What is its monthly revenue from each group and in total?

$12,500,000
$15,000,000
$20,000,000
$47,500,000	Gain = $12 M per month

3. What do you call the practice described in question 2? Price discrimination. Explain briefly.

4. What if MegaStiff started with only two distribution channels for MSDoesEverything: stores and subscriptions? In that case, techie demand is partially included in residential and business demand, so that Q_r= 400,000 – 2000P, Q_b = 300,000 - 1000P. What would MegaStiff charge each of these two groups for MSDoesEverything? $100, $150. How many units does it sell a month? 200,000, 150,000. What are its monthly revenues from each group, and what are its total monthly receipts from the sale of MSDoesEverything? $20,000,000, $22,500,000, $42,500,000.

5. Now, assume that MegaStiff discovers online sales, so that demand is as in part 2 above, when this option is offered. How much do unit sales of MSDoesEverything and total revenue from sales increase from of offering the online sales option to techies? How much do store and subscription sales and revenues decrease? Techie revenues are up $12,500,000, but revenues are down in channels R & B by $5,000,000 and $2,500,000 respectively, for a net gain of only $5,000,000: $42.5M to $47.5M.

6. What do we call the practice described in question 5? Product differentiation. How is it different from the practice described in question 2? Explain briefly.

7. Let us say that techies will pay no more than $10 for MSDoesEverything, were it sold online. How many downloads would MegaStiff have to sell a month for it to offset completely its lost in store and subscription sales? 750,000 per month.

8. You are trying to determine whether it makes sense to buy a house or to continue renting for $1000. You start looking at houses but decide that you will not purchase a house unless it is more profitable than renting. What price house is equivalent to $1000 in rent? Make several assumptions:

Assume that property taxes plus any transactions costs incurred in buying and selling the house will exactly be offset by the capital gains on the house. There will be no inflation. Your nominal rent will not increase.
Assume that you can borrow the purchase price at 5%. This is both a real and a nominal rate. Your investments also earn 5%.
Assume that you do not pay any principle on the mortgage, only interest.

What is your annualized current rent? What principle amount would imply an interest payment that would be equal to your annual rental payment, i.e., your breakeven rent?

$12,000, $240,000.

9. Assume that you will make enough money to put yourself in a 33 percent tax bracket and mortgage interest is wholly deductible. Now, what is your breakeven house price? $360,000.

10. Assume that you are risk neutral, you think there is a 75 percent chance that you will make enough to put yourself in a 33 percent tax bracket (mortgage interest is still wholly deductible), and a 25 percent chance that you will stay in the 0 percent tax bracket, now what is your breakeven house price? $330,000.