A manufacturer of CD players currently sells them domestically for price v1, and allows foreign customers to purchase them by mail for price v2 where v1, v2 are the domestic and foreign reservation prices The problem is that frequent travelers are tempted to purchase the CD players domestically, then sell them overseas. Assume risk-neutrality.
a. How high would transportation costs/tariffis have to be to render this practice unprofitable for travelers?
b. Now suppose that transportation costs and tariffis are zero, but each CD player breaks down in the first year with probability p. Assume for simplicity that consumer valuation of a good that breaks down during the first year is zero. The manufacturer attempts to stop arbitrage by voiding all warranties overseas, unless the CD player was purchased directly through the mail. Give the necessary condition relating v1, v2, and p for the manufacturer to be successful.