Explain how incomplete information can cause market failure

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Problem 1. The following is taken from the San Jose Mercury News, July 27, 2000:

"The Mexican arm of U.S. Internet giant America Online Inc. said on Wednesday it started a financing program to help aid in the purchase of personal computers, joining a list of companies that have launched similar programs to promote Internet use.

"AOL will be joined in the program by computer giant Compaq Computer Corp. and Mexico's second-largest banking group BanamexAccival, AOL said in a statement.

"The program, known as ‘PC Facil' (Easy PC) aims to help clients acquire a PC, enabling them to hook up to the Internet and the ‘unique benefits' of AOL service, said AOL Director of Markets Erick Sydow. In Mexico there are only an estimated five personal computers per 100 people, which is one of the reasons that Internet use there is still low."

Using the economic analysis, briefly answer each of the three questions below:

A. What potential benefits did AOL expect to receive from subsidizing computer sales in Mexico?

B. b. What observations can you make about the cross-elasticity of demand for AOL services and computer ownership?

Problem 2. You operate a small but popular and profitable restaurant/bar in a college town. There are several other restaurants and bars nearby. You have conducted a market research study and discovered that the price elasticity of demand for local residents is lower (less elastic) than the price elasticity of demand for college students, who are usually in town only while the college is in session about 9 months out of the year. Discuss at least two pricing strategies you can use to increase your revenues and analyze them in terms of their ability to generate additional profits. Indicate any additional assumptions you are making

Problem 3. Last year the owner of an auto dealership changed her sales manager's compensation plan. Previously, the manager received a fixed compensation. After the change, the manger's compensation was based on a percentage of sales. Compared to last year, sales have increased substantially but profits declined. Using economic analysis, explain the outcome and then recommend additional changes that would correct the situation.

Problem 4. Explain how incomplete information can cause market failure. Give at least one example of this type of market failure and explain how government intervention has been used to correct the problem. How effective has this form of intervention been? Use the material from this course to support your answer.

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