ECON311-201 Final Exam

The market demand in a Bertrand duopoly is P = 15 − 4Q, and the marginal costs are $3. Fixed costs are zero for both firms. Which of the following statement(s) is true?

$3

The accompanying table contains different consumers' values (in dollars) for three oral care products sold by a single manufacturer (Colgate): toothpaste, mouthwash, and dental floss. Different types of consumers vary in their valuation of the products alone or together. Suppose there are 100 consumers of each type. It costs Colgate $1 to produce each piece of oral care product. If Colgate charges $2 for each product separately, its profits will be

$300

You are the manager of a firm that competes against four other firms by bidding for government contracts. While you believe your product is better than the competition, the government purchasing agent views the products as identical and purchases from the firm offering the best price. Total government demand is Q = 800 −10P and all five firms produce at a constant marginal cost of $50. For security reasons, the government has imposed restrictions that permit a maximum of five firms to compete in this market; thus entry by new firms is prohibited. A member of Congress is concerned because no restrictions have been placed on the price that the government pays for this product. In response, she has proposed legislation that would award each existing firm 20 percent of a contract for 100 units at a contracted price of $70 per unit. If this legislation is passed, by how much should you expect your profits to change?

$400 Absent the legislation, this homogeneous product Bertrand oligopoly will result in marginal cost pricing and zero profits. Under the legislation, you will earn a profit of $70 − $50 = $20 on each unit sold. Your 20 percent of the contract amounts to 20 units, so your total profits under the congresswoman's plan is $400 compared to the $0 you will earn under cutthroat Bertrand competition. Therefore, you should support the legislation.

Two identical firms compete as a Cournot duopoly. The demand they face is P = 100 − 2Q. The cost function for each firm is C(Q) = 4Q. Each firm earns equilibrium profits of

$512.

During spring break, students have an elasticity of demand for a trip to Las Vegas of −5. How much should an airline charge students for a ticket if the price it charges the general public is $660? Assume the general public has an elasticity of −3.

$550

The accompanying figure presents information for a one-shot game. Firm AFirm B Low PriceHigh PriceLow Price(2,2)(10,−8)High Price(−8,10)(6,6) If this one-shot game is repeated 100 times, the Nash equilibrium payoffs of the players will be ________________ in each period.

(2,2)

Consider the following entry game: Here, firm B is an existing firm in the market, and firm A is a potential entrant. Firm A must decide whether to enter the market (play "enter") or stay out of the market (play "not enter"). If firm A decides to enter the market, firm B must decide whether to engage in a price war (play "hard") or not (play "soft"). By playing "hard," firm B ensures that firm A makes a loss of $1 million, but firm B only makes $1 million in profits. On the other hand, if firm B plays "soft,", the new entrant takes half of the market, and each firm earns profits of $5 million. If firm A stays out, it earns zero while firm B earns $10 million. Which of the following are Nash equilibrium strategies?

(not enter, hard) and (enter, soft)

A monopoly produces X at a marginal cost of $80 per unit and charges a price of $100 per unit. Determine the elasticity of demand at the profit-maximizing price of $100.

-5

The accompanying graph depicts a normal-form game of price competition. Firm AFirm B Low PriceHigh PriceLow Price0,0(10, −2)High Price(−10, 10)(8, 8) Suppose both firms agreed to charge a high price, but firm A deviates and charges a low price. What is the present value of A's payoff from cheating?

10

Two identical firms compete as a Cournot duopoly. The demand they face is P = 100 − 2Q. The cost function for each firm is C(Q) = 4Q. The equilibrium output of each firm is

16.

The accompanying graph depicts a normal-form game of price competition. Firm AFirm B Low PriceHigh PriceLow Price0,025,-5High Price-5,2510,10 Suppose the game is infinitely repeated, and the interest rate is 5 percent. Both firms agree to charge a high price, provided no player has charged a low price in the past. If both firms stick to this agreement, then the present value of firm B's payoffs is

210

Consider a monopoly facing a demand structure where the price elasticity of demand is −1.25. The optimal markup factor is

5 times marginal cost.

best response function

A function that defines the profit-maximizing level of output for a firm for given output levels of another firm.

While there is a degree of differentiation between major grocery chains like Albertsons and Kroger, the regular offering of sale prices by both firms for many of their products provides evidence that these firms engage in price competition. For markets where Albertsons and Kroger are the dominant grocers, this suggests that these two stores simultaneously announce one of two prices for a given product: a regular price or a sale price. Suppose that when one firm announces the sale price and the other announces the regular price for a particular product, the firm announcing the sale price attracts 1,000 extra customers to earn a profit of $5,000, compared to the $3,000 earned by the firm announcing the regular price. When both firms announce the sale price, the two firms split the market equally (each getting an extra 500 customers) to earn profits of $2,000 each. When both firms announce the regular price, each company attracts only its 1,500 loyal customers and the firms each earn $4,500 in profits. Two combinations of pricing strategies are equilibria of the pricing game described above when played once. What are they? Which of the following mechanisms might solve the dilemma of choosing a pricing strategy?

A. Albertsons and Kroger charge the sale price.Correct Albertsons and Kroger charge the regular price.Correct Albertsons charges the sale price and Kroger charges the regular price.Correct Albertsons charges the regular price and Kroger charges the sale price. Correct B. Guarantee Everyday low prices

Stackelberg oligopoly`

An industry in which (1) there are few firms serving many consumers, (2) firms produce either differentiated or homogeneous products, (3) a single firm (the leader) chooses an output before rivals select their outputs, (4) all other firms (the followers) take the leader's output as given and select outputs that maximize profits given the leader's output, and (5) barriers to entry exist.

Bertrand oligopoly

An industry in which (1) there are few firms serving many consumers, (2) firms produce identical products at a constant marginal cost, (3) firms compete in price and react optimally to competitors' prices, (4) consumers have perfect information and there are no transaction costs, and (5) barriers to entry exist.

Amber and Tom own the only two dry cleaning businesses. Although they have different constant marginal costs, they both survive continued competition. Amber and Tom do not constitute a:

Bertrand oligopoly.

simultaneous-move game

Game in which each player makes decisions without knowledge of the other players' decisions.

sequential-move game

Game in which one player makes a move after observing the other player's move.

repeated game

Game in which the underlying game is played more than once.

one-shot game

Game in which the underlying game is played only once.

Which of the following is true?

In a finitely repeated game with a certain end period, collusion is unlikely because effective punishments cannot be used during any time period.

A function that defines the combinations of outputs produced by all firms that yield a given firm the same level of profits.

Isoprofit curve

During the 1980s, most of the world's supply of lysine was produced by a Japanese company named Ajinomoto. Lysine is an essential amino acid that is an important livestock feed component. At this time, the United States imported most of the world's supply of lysine—more than 30,000 tons—to use in livestock feed at a price of $1.65 per pound. The worldwide market for lysine, however, fundamentally changed in 1991 when U.S.-based Archer Daniels Midland (ADM) began producing lysine—a move that doubled worldwide production capacity. Experts conjectured that Ajinomoto and ADM had similar cost structures and that the marginal cost of producing and distributing lysine was approximately $0.70 per pound. Despite ADM's entry into the lysine market, suppose demand remained constant at Q = 208 − 80P (in millions of pounds). Shortly after ADM began producing lysine, the worldwide price dropped to $0.70. By 1993, however, the price of lysine shot back up to $1.65.Which sequence of pricing strategies is most consistent with the evolution of prices described above?

Monopoly, Bertrand, Collusive

Suppose a United Auto Workers (UAW) labor contract with General Dynamics is being renegotiated. Some of the many issues on the table include job security, health benefits, and wages. If you are an executive in charge of human resource issues at General Dynamics, would you be better off: (a) letting the union bear the expense of crafting a document summarizing its desired compensation, or (b) making the union a take-it-or-leave-it offer?

Option b: Making the union a take-it-or-leave-it offer The savings from letting the union use its own pen and ink to craft the document are most likely small compared to the advantage you would gain by making a take-it-or-leave-it offer.

Which of the following statements is true regarding a simple pricing rule for monopoly and monopolistic competition?

P = [EF/(1 + EF)]MC.

CH.11 Which of the following statements is true regarding profit-maximizing markup for a Cournot oligopoly with N identical firms?

P = [NEM/(1 + NEM)]MC.

When a worker announces that he plans to quit, say next month, the "threat" of being fired has no bite. The worker may find it in his interest to shirk. What can the manager do to overcome this problem?

Provide the worker some rewards for good work that extend beyond the termination of employment with the firm.

Consider a Stackelberg duopoly with the following inverse demand function: P = 1,200 − 3Q1 − 3Q2. The firms' marginal costs are identical and are given by MCi = 6. Based on this information, the Stackelberg follower's reaction function is

Q2 = 199 − 0.5Q1.

Which would you expect to make the highest profits, other things being equal?

Stackelberg leader

In an attempt to increase tax revenues, legislators in several states have introduced legislation that would increase state excise taxes. Between Sweezy oligopoly, Cournot oligopoly, and Bertrand oligopoly, which of these market settings is likely to generate the greatest increase in tax revenues.

Sweezy Oligopoly

Which of the following is true about a Sweezy oligopoly?

The marginal revenue function has a downward "jump" or "discontinuity."

Which of the following is not true?

The notion of credible threats makes more sense in normal-form representations than in extensive-form representations of a game.

Japanese officials are considering a new tariff on imported pork products from the United States in an attempt to reduce Japan's reliance on U.S. pork. Due to political pressure, the U.S. International Trade Representative's (ITR) office is also considering a new tariff on imported steel from Japan. Officials in both Japan and the U.S. must assess the social welfare ramifications of their tariff decisions. Reports from a reliable think-tank indicate the following: 1. If neither country imposes a new tariff, social welfare in Japan's economy will remain at $10 billion and social welfare in the United States will remain at $50 billion. 2. If both countries impose a new tariff, welfare in the United States declines to $49.1 billion and welfare in Japan declines to $9.5 billion. 3. If Japan does not impose a tariff but the United States does, projected welfare in Japan is $8.9 billion while welfare in the United States is $52.5 billion. 4. Finally, if the U.S. does not impose a tariff but Japan does, welfare is projected at $48.2 billion in the United States and $11.4 billion in Japan. Determine the Nash equilibrium outcome when policy makers in the two countries simultaneously but independently make tariff decisions in a myopic (one-shot) setting. - (49.1, 9.5) Is it possible for the two countries to improve their social welfare if they are able to "agree" to different strategies? (Yes - they could both be better off if they are able to "agree" on their strategies.)

a. (49.1,9.5) b. Yes - they could both be better off if they are able to "agree" on their strategies.

For each market listed below, determine whether it is best characterized as a Cournot oligopoly, Stackelberg oligopoly, or Bertrand oligopoly. a. Oil production. Each firm produces output independently and the market price is determined by the total amount produced. b. Diamond production. DeBeers is the leader that sets diamond production, and smaller firms follow with their own levels of production. c. Competitive bidding by identical landscaping contractors. The landscaping contractors bidding the lowest fee wins the contract.

a. Cournot oligopoly b. Stackelberg oligopoly c. Bertrand oligopoly

CH.9 The graph below illustrates two demand curves for a firm operating in a differentiated product oligopoly. Initially, the firm charges a price of $60 and produces 10 units of output. One of the demand curves is relevant when rivals match the firm's price changes; the other demand curve is relevant when rivals do not match price changes. a. Which demand curve is relevant when rivals will match any price change? b. Which demand curve is relevant when rivals will not match any price change? c. Suppose the manager believes that rivals will match price cuts but will not match price increases. (1) What price will the firm be able to charge if it produces 20 units? (2) How many units will the firm sell if it charges a price of $70? (3) For what range in marginal cost will the firm continue to charge a price of $60?

a. D2 (the steeper curve) b. D1 (the flatter curve) c(1). 20 c(2). 0 c(3). $20 to $50. At a price of $60, MR = $20 for D2 and MR = $50 for D1. Therefore, $60 will be optimal for MC anywhere in this range.

Consider a homogeneous-product duopoly where each firm initially produces at a constant marginal cost of $200 and there are no fixed costs. Determine what would happen to each firm's equilibrium output and profits if firm 2's marginal cost increased to $210 but firm 1's marginal cost remained constant at $200 in each of the following settings: a. Cournot duopoly. b. Sweezy oligopoly.

a. Firm 1's output and profits would increase. Firm 2's output and profits would decrease. b. There likely would be no change in output or profits.

CH. 10 Use the following, one shot, normal-form game to answer the accompanying questions. a. Find each player's dominant strategy. Player 1's dominant strategy: [ Player 1 has no dominant strategy ] Player 2's dominant strategy: [ Player 2 has no dominant strategy ] b. Find each player's secure strategy. Player 1's secure strategy: [ B ] Player 2's secure strategy: [ E ] c. Find the Nash equilibrium for each player. Player 1's Nash equilibrium: [ B ] Player 2's Nash equilibrium: [ E ]

a. Neither player has a dominant strategy. b. Given the worst possible scenario, the highest guaranteed payoff for Player 1 is strategy B and the highest guaranteed payoff for Player 2 is strategy E. c. Nash equilibrium states, given the strategies of other players, no player can improve their payoff by unilaterally changing their own strategy. Therefore, Nash equilibrium for Player 1 is strategy B and Nash equilibrium for Player 2 is strategy E.

Use the following payoff matrix for a simultaneous-move one-shot game to answer the accompanying questions. Player 2 StrategyCDEFPlayer 1 - A - 6, 147, 1118, 2010, 19 B - 12, 515, 17, 2516, 17 a. What is player 1's optimal strategy? strategy A b. Determine player 1's equilibrium payoff. 18

a. Player 1's optimal strategy is A. Player 1 does not have a dominant strategy. However, by putting herself in her rival's shoes, Player 1 should anticipate that Player 2 will choose E (since E is Player 2's dominant strategy). Player 1's best response to E is A. b. Player 1's equilibrium payoff is 18.

Use the following payoff matrix for a simultaneous-move one-shot game to answer the accompanying questions. Player 2 StrategyCDEFPlayer 1 - A - 23, 2114, 519, 158, 14 B - 7, 2324, 1012, 1419, 17 a. What is player 1's optimal strategy? strategy A b. Determine player 1's equilibrium payoff. 23

a. Player 1's optimal strategy is Strategy A. Player 1 does not have a dominant strategy. However, by putting herself in her rival's shoes, Player 1 should anticipate that Player 2 will choose Strategy C (since Strategy C is Player 2's dominant strategy). Player 1's best response to Strategy C is Strategy A. b. Player 1's equilibrium payoff is 23.

You are the manager of a firm that manufactures front and rear windshields for the automobile industry. Due to economies of scale in the industry, entry by new firms is not profitable. Toyota has asked your company and your only rival to simultaneously submit a price quote for supplying 100,000 front and rear windshields for its newest version of the Highlander. If both you and your rival submit a low price, each firm supplies 50,000 front and rear windshields and earns a zero profit. If one firm quotes a low price and the other a high price, the low-price firm supplies 100,000 front and rear windshields and earns a profit of $11 million and the high-price firm supplies no windshields and loses $2 million. If both firms quote a high price, each firm supplies 50,000 front and rear windshields and earns a $6 million profit. Determine your optimal pricing strategy if you and your rival believe that the new Highlander is a "special edition" that will be sold only for one year. (Price low) Would your answer differ if you and your rival were required to resubmit price quotes year after year and if, in any given year, there was a 70 percent chance that Toyota would discontinue the Highlander? (No - a collusive outcome cannot be sustained as a Nash equilibrium.)

a. Price Low b. No - a collusive outcome cannot be sustained as a Nash equilibrium.

Ford executives announced that the company would extend its most dramatic consumer incentive program in the company's long history—the Ford Drive America Program. The program provides consumers with either cash back or zero percent financing for new Ford vehicles. As the manager of a Ford franchise, how would you expect this program to impact your firm's bottom line?

a. Profits likely will increase in the short run but return to normal in the long run as rivals respond with similar plans.

Analysts have estimated the inverse market demand in a homogeneous-product Cournot duopoly to be P = 150 −2 (Q1 + Q2). They estimate costs to be C1(Q1) = 16Q1 and C2(Q2) = 26Q2. a. Determine the reaction function for each firm. Firm 1: Q1= [33.5] - [0.5]Q2 Firm 2: Q2=[31] - [0.5]Q1 b. Calculate each firm's equilibrium output. Firm 1: Firm 2: c. Calculate the equilibrium market price. $[. ] d. Calculate the profit each firm earns in equilibrium. Firm 1: Firm 2:

a. Q1 = [(a - c1)/2b] − (1/2)Q2 = [(150 − 16)/2(2)] − (1/2)Q2 = 33.5 − 0.5Q2 and Q2 = [(a - c2)/2b] − (1/2)Q1 = [(150 − 26)/2(2)] − (1/2)Q1 = 31 − 0.5Q1. b. Q1 = 24; Q2 = 19. c. P = 150 −2(43) = $64. d. Π1 = $1,152; Π2 = $722.

The inverse demand for a homogeneous-product Stackelberg duopoly is P = 18,000 −5Q. The cost structures for the leader and the follower, respectively, are CL(QL) = 2,000QL and CF (QF) = 4,000QF. a. What is the follower's reaction function? b. Determine the equilibrium output level for both the leader and the follower. c. Determine the equilibrium market price. d. Determine the profits of the leader and the follower.

a. QF = (a − cF)/2b − (1/2)QL = (18,000 − 4,000)/2(5) − (1/2)QL = 1,400 − 0.5QL b. QL = 1,800; QF = 500. c. P = 18,000 −5(2,300) = $6,500. d. ΠL = $8,100,000; ΠF = $1,250,000.

The opening statement on the Web site of the Organization of Petroleum Exporting Countries (OPEC) says its members seek " . . .to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry."To achieve this goal, OPEC attempts to coordinate and unify petroleum policies by raising or lowering their collective oil production. However, increased production by the United States, Russia, Oman, Mexico, Norway, and other non-OPEC countries has placed downward pressure on the price of crude oil. To achieve its goal of stable and fair oil prices, what must OPEC do to maintain the price of oil at its desired level? Why might this be difficult for OPEC to do?

a. Reduce output. b. Member profits will be lower, so each member may be more willing to cheat on the collusive production levels.

Consider a Bertrand oligopoly consisting of four firms that produce an identical product at a marginal cost of $100. Analysts estimate that the inverse market demand for this product is P = 800 −4Q. a. Determine the equilibrium level of output in the market. b. Determine the equilibrium market price. c. Determine the profits of each firm.

a. Set P = MC to get 800 −4Q = $100. Solving yields Q = 175 units. b. P = MC = $100. c. Each firm earns zero economic profits.

You manage a company that competes in an industry that is comprised of five equal-sized firms. A recent industry report indicates that a tariff on foreign imports would boost industry profits by $30 million—and that it would only take $5 million in expenditures on (legal) lobbying activities to induce Congress to implement such a tariff. Indicate whether each of the following statements are true or false. a. It is an equilibrium for your company to pay the $5 million in lobbying expenses and your rivals pay nothing? (T or F) b. It is an equilibrium for your company to pay nothing and your rivals to collectively pay the $5 million in lobbying expenses? (T or F) c. It is an equilibrium for each company to pay $1 million in lobbying expenses? (T or F) d. Which of the following is the natural "focal point" of this game?

a. T b. T c. T d. Each company pays $1 million in lobbying expenses. If Congress passes the tariff, each firms gains $6 million in "extra" profit (= $30/5). If your firm commits to not spending any money on lobbying, one or more of the other firms in the industry would have an incentive to collectively spend $5 million on lobbying. Under this scenario, your "optimal" profits are $6, compared to profits of $1 million when you pay $5 million on lobbying. However, if your rivals knew that you were willing to pay the entire lobbying bill, your threat is not credible and your competitors would not be inclined to spend any money on lobbying. More formally, this is a coordination game with multiple Nash equilibria. In one of the equilibria, your firm spends nothing on lobbying and one or more competitors collectively spend $5 million on lobbying such that the proposed tariff passes. Another equilibrium occurs when your rival firms spend nothing on lobbying activities and you pay the entire $5 million in lobbying expenses. The natural "focal point" is for each firm to agree to spend $1 million on lobbying. This results in each of the five firms earning a profit (net of lobbying costs) of $5 million.

Firms will often implement randomized pricing in an attempt to reduce

both customer and competitor information about price.

The purpose of randomized pricing is to reduce

both customer and competitor information about price.

If you advertise and your rival advertises, you each will earn $4 million in profits. If neither of you advertises, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $1 million and the non-advertising firm will earn $5 million. Suppose this game is repeated for a finite number of times, but the players do not know the exact date at which the game will end. The players can earn profits of $10 each period as a Nash equilibrium to a repeated play of the game if the probability the game terminates at the end of any period is

close to 0 or 1 or between 0 and 1.

Which of the following enhances the ability of waste companies to collude?

decals on waste receptacles

The accompanying table contains different consumers' values (in dollars) for three oral care products sold by a single manufacturer (Colgate): toothpaste, mouthwash, and dental floss. Different types of consumers vary in their valuation of the products alone or together. Suppose there are 100 consumers of each type. It costs Colgate $1 to produce each piece of oral care product. If Colgate charges $1.50 for each product, it will sell

dental floss to 2 consumer types, mouthwash to 1 consumer type, and toothpaste to 1 consumer type.

If you advertise and your rival advertises, you each will earn $4 million in profits. If neither of you advertises, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $1 million and the non-advertising firm will earn $5 million. If you and your rival plan to be in business for only one year, the Nash equilibrium is

for neither firm to advertise.

Which of the following pricing policies enhances profits by creating brand-loyal consumers?

frequent flyer programs

In the accompanying game, firms 1 and 2 must independently decide whether to charge high or low prices. Firm 1Firm 2 High PriceLow PriceHigh Price(10,10)(5,−5)Low Price(5,−5)(0,0)

high price

Second-degree price discrimination

is the practice of posting a discrete schedule of declining prices for different ranges of quantities.

Firms will try to signal superior quality of their goods by

issuing warranties or guarantees.

The inverse demand in a Cournot duopoly is P = a − b(Q1 + Q2), and costs are C1(Q1) = c1Q1 and C2(Q2) = c2Q2. The government has imposed a per-unit tax of $t on each unit sold by each firm. The tax revenue is

less than t times the total output of the two firms should there be no sales tax.

In the presence of large sunk costs, which of the following market structures generally leads to the highest price?

monopoly

Ed just finished an empirical study of oligopoly. He found the following result: "In the examined industry, a firm's demand curve is such that other firms match price increases but do not match price reductions." What kind of oligopoly is the examined industry?

none of the provided answers

If you advertise and your rival advertises, you each will earn $4 million in profits. If neither of you advertises, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $1 million and the non-advertising firm will earn $5 million. Which of the following is true?

none of these

A Nash equilibrium with a noncredible threat as a component is

not a subgame perfect equilibrium.

After the the Persian Gulf War, the world price of oil fell. But in some areas of the world, consumers saw little relief at the pump. This phenomenon can be explained by the theory of

oligopoly

Game theory is especially useful for analysis in which of the following markets?

oligopoly

Industry profits are maximized in the accompanying figure (QM1 = QM2)

on the line segment joining points QM1 and QM2.

If firms compete in a Cournot fashion, then each firm views the

output of rivals as given.

A Broadway theater sells weekday show tickets at a lower price than for a weekend show. This is an example of

price discrimination or peak-load pricing.

A campus auditorium sells tickets at half price to students during the last 30 minutes before a concert starts. This is an example of

price discrimination or peak-load pricing.

Consider a Cournot duopoly with the following inverse demand function: P = 50 − 0.2Q1 − 0.2Q2. The firms' marginal costs are identical and are given by MCi(Qi) = 2. Based on this information, firm 1 and 2's reaction functions are

r1(Q2) = 120 − 0.5Q2 and r1(Q2) = 120 − 0.5Q1.

The average consumer at a firm with market power has an inverse demand function of P = 10 − Q. The firm's total cost function is C = 2Q. If the firm engages in two-part pricing, what is the optimal fixed fee to charge each consumer?

$32

Two identical firms compete as a Cournot duopoly. The inverse market demand they face is P = 80 − 4Q. The cost function for each firm is C(Q) = 8Q. The price charged in this market will be

$32

A monopoly producing a chip at a marginal cost of $6 per unit faces a demand elasticity of −2.5. Which price should it charge to optimize its profits?

$10 per unit

Refer to the normal-form game of price competition shown below. Firm AFirm B CDA0,75,2B5,10,8 Which of the following represents firm B's strategies?

{C, D}

Consider two firms competing to sell a homogeneous product by setting price. The inverse demand curve is given by P = 6 − Q. If each firm's cost function is Ci(Qi) = 2Qi, then consumer surplus in this market is

8

contestable market

A market in which (1) all firms have access to the same technology, (2) consumers respond quickly to price changes, (3) existing firms cannot respond quickly to entry by lowering their prices, and (4) there are no sunk costs.

Oligopoly

A market structure in which there are only a few firms, each of which is large relative to the total industry.

Refer to the accompanying normal-form game of price competition. Firm AFirm B CDA50, 50500−x, 200B100, 500−x50, 50 For what values of x is strategy D strictly dominant for firm B?

All x > 450.

Sweezy oligopoly

An industry in which (1) there are few firms serving many consumers, (2) firms produce differentiated products, (3) each firm believes rivals will respond to a price reduction but will not follow a price increase, and (4) barriers to entry exist.

Suppose that the inverse demand for a downstream firm is P = 150 − Q. Its upstream division produces a critical input with total costs of CU(Qd) = 5(Qd)2. The downstream firm's total cost is Cd(Q) = 10Q. When there is no external market for the downstream firm's critical input, the marginal revenue for the downstream firm in transfer pricing is

MRd(Q) = 150 − 2Q.

An increase in firm 2's marginal cost will cause

a downward shift in firm 2's reaction function, resulting in a new Cournot equilibrium where firm 1 is producing a higher quantity and firm 2 is producing a lower quantity.

Consider a two-player, sequential-move game where each player can choose to play right or left. Player 1 moves first. Player 2 observes player 1's actual move and then decides to move right or left. If player 1 moves right, player 1 receives $0 and player 2 receives $25. If both players move left, player 1 receives −$5 and player 2 receives $10. If player 1 moves left and player 2 moves right,player 1 receives $20 and player 2 receives $20. (Hint: Before answering the questions below, write the above game in extensive form). a. Find the Nash equilibrium outcomes to this game. ($0, $25) and ($20, $20) b. Which of the equilibrium outcomes is most reasonable? ($20, $20)

a. ($0, $25) and ($20, $20). b. ($20, $20) is the only subgame perfect equilibrium; the only reason ($0, $25) is a Nash equilibrium is because Player 2 threatens to play left if 1 plays left. This threat isn't credible.

Use the following normal-form game to answer the questions below. Player 2 StrategyCDPlayer 1 A - 10, 1060, -5 B - -5, 6050, 50 a. Identify the one-shot Nash equilibrium. (A,C) b. Suppose the players know this game will be repeated exactly three times. Can they achieve payoffs that are better than the one-shot Nash equilibrium? (NO) c. Suppose this game is infinitely repeated and the interest rate is 5 percent. Can the players achieve payoffs that are better than the one-shot Nash equilibrium? (YES) d. Suppose the players do not know exactly how many times this game will be repeated, but they do know that the probability the game will end after a given play is θ. If θ is sufficiently low, can players earn more than they could in the one-shot Nash equilibrium? (YES)

a. (A, C). b. No. This is a finitely played game with 3 rounds. Players know that round 3 is the last round, so they will treat that as a one shot game (or as if there is no tomorrow). Therefore, they both cheat in round 3. Because they know they will both cheat in round 3 and that they can't punish them for it in a future round, they cheat in round 2. This continues to unravel and they cheat in every round. c. If firms adopt the trigger strategies outlined in the text, higher payoffs can be achieved if (πCheat − πCoop)/(πCoop − πN) ≤ (1/i) . Here, πCheat = 60, πCoop = 50, πN = 10, and the interest rate is i = .05. Since (πCheat − πCoop)/(πCoop − πN) = (60 − 50)/(50 − 10) = 0.25 < (1/i) = 20.00, each firm can indeed earn a payoff of 50 via the trigger strategies. d. Yes. With θ sufficiently low, this resembles the infinitely repeated game.

There are many different models of oligopoly because

beliefs play an important role in oligopolistic competition and oligopoly is the most complicated type of market structure.

The accompanying table contains different consumers' values for three software titles: PowerPoint, Excel, and Word. Suppose there are 100 consumers of each type. It costs Microsoft $5 to produce each piece of software. If Microsoft wants to devise a pricing strategy that is incentive compatible between consumer types and will maximize its profit, then it should

charge a single price of $300 for the bundle of PowerPoint, Excel, and Word.

One of the characteristics of a contestable market is that

consumers react quickly to a price change.

A necessary cost-side condition for a firm to implement a cross-subsidization pricing strategy is

economies of scope.

If a product is perceived by consumers as homogeneous, which of the following strategies will work to induce brand loyalty?

frequent buyer rebate programs

Which of the following is not an important determinant of collusion in pricing games?

the average fixed cost to produce the product

A market is not contestable if

there are sunk costs.

A finitely repeated game differs from an infinitely repeated game in that

there is an end-of-period problem for the former.

Which of the following pricing strategies is not used in markets characterized by intense price competition?

transfer pricing

Refer to the accompanying normal-form game of advertising depicted here. Firm AFirm B AdvertiseDo Not AdvertiseAdvertise$0, $0$175, −$100Do Not Advertise−$100, $175$125, $125 Suppose there is a 90 percent chance that the advertising game shown above will end in the next period. The collusive agreement {(not advertise, not advertise)} is

unstainable since $175 > $138.89.