Consider the following highly simplified picture of the personal computer industry. here are many price-taking firms that assemble computer systems. Call these firms "computer OEMs." Each of these firms must buy three inputs for each computer system that it sells: (1) a variety of components that are themselves supplied competitively and collectively cost the computer OEM $500 per computer; (2) the Windows operating system, available only from Microsoft, at a price pM , to be discussed later; and (3) a Pentium microprocessor, available only from Intel, at a price pI, also to be discussed later. Because each computer system requires precisely one operating system and one microprocessor, the marginal cost of a computer to an OEM is 500 + pM + pI. Assume that competition among OEMs drives the price of a computer system down to marginal cost; we have p = 500 + pM + pI, where p is the price of a computer system.

The demand for computer systems is given by Q = 100, 000, 000 − 50, 000p.

Microsoft is the sole supplier of the Windows operating system for personal computers. The marginal cost to Microsoft of providing Windows for one more computer is zero. Intel is the sole supplier of the Pentium microprocessors for personal computers. The marginal cost to Intel of a Pentium microprocessor for one more computer system is $300.

Required:
a. Suppose that Microsoft and Intel simultaneously and independently set the prices for Windows and Pentium chips, pM and pI. What are the Nash equilibrium prices, pˆ M and pˆI ?
b. What package price would maximize Microsoft’s and Intel’s combined profits? By how much would an agreement between Microsoft and Intel boost their combined profits?
c. Would final consumers benefit from such an agreement between Microsoft and Intel, or would they be harmed? What about computer OEMs?