Paper 1 Practice: Velora’s Cloud-Gaming Market
Original practice material
Velora, PlayArc and all numerical evidence are fictional and constructed for this case. This is one 30-mark case study, not a complete Paper 1.
Case Study: Growth, pricing and market power
Extract 1: PlayArc’s output decision
PlayArc supplies monthly cloud-gaming subscriptions. It faces a downward-sloping demand curve because its catalogue differs from rivals’. Table 1 gives a simplified monthly schedule. Output is measured in millions of subscriptions and money values in V$ million. Thus, for example, an output of 3 means 3 million subscriptions. Total cost includes a V$30 million fixed server-and-software cost.
Table 1: Constructed price, revenue and cost schedule
| Output | Price per subscription (V$) | Total revenue (V$m) | Total cost (V$m) |
|---|---|---|---|
| 0 | - | 0 | 30 |
| 1 | 22 | 22 | 35 |
| 2 | 20 | 40 | 42 |
| 3 | 18 | 54 | 51 |
| 4 | 16 | 64 | 62 |
| 5 | 14 | 70 | 75 |
Managers can identify subscriber groups by verified student status and country. Accounts cannot legally be resold.
The schedule is a one-period estimate that holds catalogue quality and rival prices constant. It excludes congestion costs at peak usage and any later renewal revenue from users acquired this month.
Extract 2: Scale and entry
Cloud gaming requires large initial investment in servers, licences and software. Once a platform has spare capacity, an extra user can sometimes be served at low additional cost. Larger platforms may negotiate lower licence fees and spread advertising and development costs across more users. However, very large networks can suffer congestion, coordination problems and slower responses to local preferences.
Users value a platform more when friends use the same service. Exclusive game contracts and accumulated user data may make entry difficult. A new rival nevertheless offers a smaller catalogue aimed at casual users.
Table 2: Selected market indicators
| Indicator | PlayArc | Two largest rivals combined | Other providers |
|---|---|---|---|
| Share of paid subscriptions (%) | 46 | 39 | 15 |
| Share of popular exclusive titles (%) | 52 | 35 | 13 |
Market shares fluctuate with game releases. Fixed server costs may generate scale economies, but the authority has not shown that the platform is a natural monopoly. Multi-homing and the casual-user entrant show that entry is possible in differentiated segments.
Extract 3: Different prices
PlayArc proposes lower student prices and higher prices in markets where demand is less responsive. Supporters say discounts expand access and fill spare capacity. Critics argue that some users will pay more for the same service. The strategy requires separation of customer groups and limits on resale or account sharing. Rival platforms may respond with their own discounts.
PlayArc estimates that student demand is more price elastic because students have lower incomes and can switch to free games. However, this estimate is based on one promotional period. Verification, billing and anti-sharing systems have additional costs. A lower student price may still be profitable if it attracts users at times when marginal server cost is low, but congestion at evening peaks would weaken that argument.
Extract 4: A regulatory choice
Velora’s competition authority is considering three responses: prohibiting long exclusive contracts, imposing a maximum subscription price, or requiring PlayArc to provide rival platforms with access to parts of its server network at a regulated charge. Officials want lower prices and more innovation but worry that strict rules could weaken investment incentives. They have incomplete information about PlayArc’s efficient costs.
Consumer complaints focus on price, game availability and occasional service interruptions. Smaller rivals argue that access to computing capacity would reduce duplication, while PlayArc says its network is not an essential facility because cloud capacity can be leased from independent suppliers. Exclusive contracts may foreclose rivals, but developers claim that advance payments help finance risky new games. Any intervention must therefore distinguish restrictions that protect investment from those that unnecessarily prevent entry.
Questions
1
(a) With reference to Table 1:
(i) Calculate PlayArc’s profit at an output of 3. [2]
(ii) Calculate the marginal revenue from increasing output from 3 to 4. [2]
(b) Explain why output 3, rather than output 4, maximises PlayArc’s profit on the supplied discrete schedule. [4]
(c) Explain two reasons why PlayArc’s long-run average cost may fall as its scale initially increases. [4]
(d) Assess whether charging different subscription prices to different groups is likely to increase PlayArc’s profit. [8]
(e) Discuss which regulatory response in Extract 4 is most likely to improve consumer welfare in Velora’s cloud-gaming market. [10]
[Total: 30]
Suggested use
Allow about 75 minutes and use the extracts selectively.
Answers: Paper 1 Velora Cloud Gaming — Answers.