Company ALFA is world-renowned for its high quality watches which are sold at a price of DKK 9,000. ALFA, however, faces the emergence of fake copies of its watches. The copy producers have become better and consumers, although aware of the existence of duplicate products in the market, cannot really distinguish between an ALFA watch and an ALFA copy. The latter product, however, is of far lower quality than the genuine product.
ALFA estimates the consumer's maximum willingness to pay for ALFA watches to be 10,000. The maximum willingness to pay for a copy product is only 1,200. A representative sample shows that the percentage of copy watches in the market is 4%. Suppose consumers are risk neutral.
a) What will be the consumer's maximum willingness to pay for an ALFA watch on the market?
b) Explain how ALFA may justify the fact that copiers do not pose a major problem.
Assume instead that there is a proportion q of true ALFA watches, and 1-q of copies.
c) What will be the consumer's maximum willingness to pay for an ALFA watch on the market? Find the value of q under which ALFA needs to revise its pricing.