Microeconomics Study Plan CH 14
Which of the following terms is a barrier to entry?
All of the above
How could repeated playing of the game change the strategy each firm uses?
All of the above are possible strategies
Actions of firms that are aimed at deterring entry include
All of the above.
Established firms are rarely vulnerable to competitors introducing a new product that fills a consumer need better than their current product does.
False
Airlines often find themselves in price wars. Consider the following game: Delta and United are the only two airlines flying the route from Houston to Omaha. Each firm has two strategies: charge a high price or charge a low price. What (if any) is the dominant strategy for each firm?
The dominant strategy for each firm is to set a low price
Until the late 1990s, airlines would post proposed changes in ticket prices on computer reservation systems several days before the new ticket prices went into effect. Then the federal government took action to end the practice. Now airlines can only post prices on their reservations systems for tickets that are immediately available for sale. Source: Scott McCartney, "Airfare Wars Show Why Deals Arrive and Depart," Wall Street Journal, March 19, 2002. Why would the federal government object to the old system of posting prices before they went into effect?
The old system provided a way for firms to explicitly collude because one firm could propose a price change and the other firms could respond before the change went into effect.
The late Thomas McCraw, while a professor at the Harvard Business School, wrote: "Throughout American history, entrepreneurs have tried, sometimes desperately, to create big businesses out of naturally small-scale operations. It has not worked." Entrepreneurs hope to increase profitability by creating "big businesses." Unless there are significant economies of scale LOADING... , they will not be successful. In the figure, firms producing at a level of output that is a small fraction of total industry sales, represented by LRAC1, have the lowest average costs for most levels of output. If a firm tries to grow to a larger size, such as that represented by LRAC2, its average costs will rise. Source: Thomas K. McCraw, ed., Creating Modern Capitalism, Cambridge, MA: Harvard University Press, 1997, p. 323. If an entrepreneur is planning on producing 2 comma 0002,000 units, should he choose the smaller or larger operation?
The smaller operationThe smaller operation.
Under "early decision" college admission plans, students apply to a college in the fall and, if they are accepted, they must enroll in that college. Some critics of early decision plans, including some college presidents, argue that the plans put too much pressure on students to decide early in their senior year in high school which college to attend. Some college administrators have proposed abolishing early decision plans, but as one newspaper headline put it: "Applicants Continue to Flock to Early Admission Programs." Source: Jacques Steinberg and Tanya Abrams, "Applicants Continue to Flock to Early Admission Programs," New York Times, December 20, 2012. Can game theory help analyze this situation? Game theory can help us analyze this situation as an example of what?
The prisoner's dilemma.
Established firms are rarely vulnerable to competitors introducing a new product that fills a consumer need better than their current product does.
True
Michael Porter has argued, "The intensity of competition in an industry is neither a matter of coincidence nor bad luck. Rather, competition in an industry is rooted in its underlying economic structure." Source: Michael Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York: The Free Press, 1980, p. 3. Which of the following factors would not be included in Porter's concept of "economic structure"?
Whether the market is monopolistic or competitive.
Is there a Nash equilibrium?
Yes. Apple chooses low and Microsoft chooses high.
Consider the entries in the row of the payoff matrix ... that correspond to Saudi Arabia choosing "low output." Suppose the numbers change so that Nigeria's profit is $15 million when Nigeria chooses "low output" and $10 million when it chooses "high output," reflected in the payoff matrix below (payoffs: Saudi Arabia, Nigeria). Given the payoff matrix above and assuming that Saudi Arabia and Nigeria choose their output levels simultaneously, is there a Nash equilibrium LOADING... to this game? If so, what is it?
Yes. Both Saudi Arabia and Nigeria choose low output
Given the decision tree above, which assumes that Saudi Arabia and Nigeria make their decisions sequentially: First Saudi Arabia chooses its output level, and then Nigeria responds by choosing its output level. Is there a Nash equilibrium to this game? If so, what is it?
Yes. Both Saudi Arabia and Nigeria choose low output.
Which of the following is not one of the competitive forces included in the competitive forces model?
government taxation
If an input is specialized and only a few firms can provide it, the profits of the firms that supply that input will be ______, and the firms will have ______ bargaining power with buyers.
high; more
Price leadership is a form of ____________ in which one firm in an oligopoly announces a price change and the other firms in the industry match the change.
implicit collusion
The effect on McDonald's as White Castle and Taco Bell consider starting to sell breakfast food. The competitive force involved in this business development is
ompetition from substitute goods or services.
How are decision trees used to analyze sequential games? A decision tree
ontains decision nodes where firms must make decisions, arrows illustrating the decisions, and terminal nodes showing the resulting rates of return.
In 2014, Walmart decided that it would begin a new policy in which its stores would match prices being charged by large Web retailers such as Amazon. For example, if it was selling a 4K television for $899 and Amazon was selling it for $799, Walmart would match Amazon's price. An economist comments that this new policy was more likely to end up raising the prices Walmart and Amazon charged than lowering them. Source: Shelly Banjo, "Wal-Mart Weighs Matching Online Prices," Wall Street Journal, October 30, 2014. The economist's reasoning is based on the concept of
signaling intent which is a form of implicit collusion
The effect on the publishing firm Hachette when Amazon bargains to lower the prices of the books Hachette sells on Amazon's site. The competitive force involved in this business development is
the bargaining power of buyers.
The effect on the Carmike movie theater chain of IMAX increasing the fees it charges to theaters to use its technology. The competitive force involved in this business development is
the bargaining power of suppliers.
The late Thomas McCraw, while a professor at the Harvard Business School, wrote: "Throughout American history, entrepreneurs have tried, sometimes desperately, to create big businesses out of naturally small-scale operations. It has not worked." Entrepreneurs hope to increase profitability by creating "big businesses." Unless there are significant economies of scale LOADING... , they will not be successful. In the figure, firms producing at a level of output that is a small fraction of total industry sales, represented by LRAC1, have the lowest average costs for most levels of output. If a firm tries to grow to a larger size, such as that represented by LRAC2, its average costs will rise. Source: Thomas K. McCraw, ed., Creating Modern Capitalism, Cambridge, MA: Harvard University Press, 1997, p. 323. If an entrepreneur is planning on producing 6 comma 0006,000 units, should he choose the smaller or larger operation?
the larger operation
The effect on cable television firms as Apple plans a Web TV service that will include programs from 25 to 30 cable networks. The competitive force involved in this business development is
the threat from potential entrants.
Given the decision tree below, TruImage's profits are $1.5 million if the firm accepts Dell's contract offer of $20 per copy. Given the decision tree above, will Dell offer TruImage a contract of $20 per copy or a contract of $30 per copy?
$30
Why do economists refer to the methodology for analyzing oligopolies as game theory? Economists refer to their methodology for analyzing oligopolies as game theory because, as in gam
. all of the above.
Give an example of a government-imposed barrier to entry. An example of a government-imposed barrier to entry is
. both a and b.
Which of the terms below is defined as "anything that keeps new firms from entering an industry in which firms are earning economic profits"?
Barriers to entry
Finding dominant strategies is often a very effective way of analyzing a game. Consider the following game: Microsoft and Apple are the two firms in the market for operating systems. Each firm has two strategies: charge a high price or charge a low price (payoffs: Microsoft, Apple). What (if any) is the dominant strategy for each firm?
Choosing low is a weakly dominant strategy for Apple.
Michael Porter has argued that in many industries " strategies converge and competition becomes a series of races down identical paths that no one can win." Source: Michael E. Porter, "What Is Strategy?" Harvard Business Review, November-December 1996, p. 64. Are firms in these industries likely to earn economic profits?
NO
Are there any differences in the outcomes of these two games and if so why?
No because Saudi Arabia's dominant strategy is to choose low output.
When Apple first launched Apple Music, singer Taylor Swift refused to allow her album 1989, which had been the best selling album of 2014, to be made available for the service because Apple did not intend to pay royalties on songs it streamed during an initial three month period when the service would be free to subscribers. In response, Apple changed its policy and agreed to pay royalties during those three months even though doing so reduced its profit. Source: Mike Ayers and Ethan Smith, "Taylor Swift Is Now Making '1989' Available on Apple Music," Wall Street Journal, June 25, 2015. Do singers typically have substantial bargaining power with Apple, Spotify, and the other streaming services?
Not unless they are top performers in the market.
Why would the government be willing to erect barriers to entering an industry? The government would be willing to impose barriers to
all of the above.
Given the decision tree above for an entry game, Wal-Mart will
build a small store.
Under Armour, Inc., was founded in 1996 by Kevin Plank, a 23-year old former University of Maryland football player. The company specializes in manufacturing and selling athletic and casual apparel made from synthetic material that repels moisture. The company does not have patents on the fabric it uses or on its manufacturing process. Source: Katherine Ariline, "Porter's Five Forces: Analyzing the Competition," Business News Daily, February 18, 2015. Michael Porter's five competitive forces are: (1) competition from existing firms, (2) the threat from potential entrants, (3) competition from substitute goods or services, (4) the bargaining power of buyers, and (5) the bargaining power of suppliers. Assume that there are many retail buyers, many suppliers in many countries provide the synthetic material for making Under Armour's athletic apparel, and strong demand is expected to continue for athletic apparel. Given this information, which of the choices below best describe the competition Under Armour faces in the athletic and casual apparel industry?
competition from existing firms and the threat from potential entrants
Briefly explain which of the five competitive forces is involved in each of the following business developments. The effect on Samsung, maker of the Galaxy large-screen smartphone, as Apple introduces the iPhone 6 with a larger screen. The competitive force involved in this business development is
competition from existing firms.
A game theory analysis of deterring entry concludes that
deterring entry may be a good or a bad idea, depending on the circumstances.
Does the strength of each of the five competitive forces remain constant over time? Briefly explain. The strength of the five competitive forces
does not remain constant over time. For example, existing firms may introduce slightly differentiated new productsintroduce slightly differentiated new products to make entry less attractive, reducing the threat from additional potential entrants.
What are the most important barriers to entry? The most important barriers to entry are
economies of scale, ownership of a key input, and government imposed barriers.
The North Carolina State Board of Dental Examiners had been requiring that only licensed dentists be allowed to sell teeth-whitening services. The board brought legal action against hair salons and spas that also offered these services arguing that only licensed dentists had the training to ensure that consumers weren't injured in the teeth-whitening process. In 2015, the U.S. Supreme Court ruled that a federal government agency had the authority to stop the board from preventing non-dentists from offering teeth-whitening services. According to a news report, the federal agency argued that "the dental board was motivated by financial self-interest, not health concerns." Source: Brent Kendall, "Supreme Court Affirms FTC Antitrust Authority Over Licensing Boards," Wall Street Journal, February 25, 2015. Because of the Supreme Court decision, you can expect the quantity of teeth-whitening services in North Carolina to
increase and the price to fall.
For several years, a professor at Johns Hopkins University had been using the following grading scheme for his final exam: He would give an A to the student with the highest score. The grades of the remaining students were then based on what percentage their scores were of the top student's score. In the fall of 2012, the students in the class came up with the idea of boycotting the final exam. They stood in the hallway outside the classroom but did not enter the room to take the exam. After waiting for a time, the professor cancelled the exam and, applying his grading scale, gave everyone in the class an A on the exam. An article in the New York Times about this incident observes: "This is an amazing game theory outcome, and not one that economists would likely predict." Source: Catherine Rampell, "Gaming the System," New York Times, February 14, 2013. Game theory indicates the students' strategy was unlikely to work because
it is difficult to get a group of people to agree and not defect.
The well-being of consumers of teeth-whitening services in North Carolina
may increase as a result of larger consumer surplus, but may decrease if there is injury as a result of non-dentists offering the services.
In his review of a book, business writer Nick Schultz cited the following passage that refers to the market for high-speed Internet access: "There are two enormous monopoly submarketslong dash—one for wireless and one for wired transmission. Both are dominated by two or three large companies." Source: Nick Schultz, "The Joys of Oligopoly," Wall Street Journal, January 10, 2013. Schultz commented on this passage that, "The claim is by definition nonsense," because
monopoly is, by defnition, a market with one firm.
How does the prisoner's dilemma compare to the outcome of a repeated game?
n a repeated game, firms are more likely to charge a high price and receive high profits.
What do barriers to entry have to do with the extent of competition, or lack thereof, in an industry? Without barriers to entry,
new firms will enter industries where firms are earning economic profits
What do barriers to entry have to do with the extent of competition, or lack thereof, in an industry? Without barriers to entry,
new firms will enter industries where firms are earning economic profits.
Suppose there are four dominant manufacturers of toilet tissue. The largest of these manufacturers announces that it will raise its prices by 15 percent due to higher paper costs. Within three days, the other three dominant toilet tissue manufacturers announce similar price hikes. The decision among the four companies to raise prices would
not be explicit collusion unless there was clear evidence of an agreement among the manufacturers.
Move studios split ticket revenues with the owners of the movie theaters that show their films. An article in the Wall Street Journal in 2015 discussed how the Disney studio was attempting to negotiate a larger share of the ticket revenue because it had a string of movies about to open that appeared likely to be very successful, including Avengers: Age of Ultron and Star Wars: The Force Awakens. Source: Erich Schwartzel and Ben Fritz, "Disney, Theater Operators Battle Over New 'Avengers,'" Wall Street Journal, May 4, 2015. Typically, would you expect that the profits of movie studios are more at risk from the bargaining power of theaters, or are the profits of theaters more at risk from the bargaining power of movie studios? The profits of
theaters are more at risk because there are more of them, making it is more difficult for them to collude and exercise bargaining power.
What is a sequential game? A sequential game is a game
where one firm acts first and then the other firms respond.
Is this game a prisoner's dilemma?
yes
Does FedEx have a dominant strategy?
Yes, the dominant strategy for FedEx is not to raise rates.
UPS and FedEx both struggle to deliver the surge of packages they receive during the end-of-year holiday season. According to an article in the Wall Street Journal, in 2014, both firms considered charging firms such as Amazon rates that would be 10 percent higher for packages delivered during the week before Christmas. Such higher rates would likely have increased the profits of both firms. In fact, though, neither company raised rates during the holiday season of 2014. Use the payoff matrix to the right to answer the following questions and shed light on why the firms may have chosen not to raise rates. Sources: Laura Stevens and Ben Fox Rubin, "UPS Cuts Earnings View, Citing Holiday Challenges," Wall Street Journal, January 17, 2014; and Laura Stevens, "UPS, FedEx Got Back On Time This Holiday," Wall Street Journal, December 29, 2014. Does UPS have a dominant strategy?
Yes, the dominant strategy for UPS is not to raise rates.
Economies of scale exist when a firm's ___________ average costs fall as it __________ output.
long-run; increases
A game where pursuing dominant strategies results in noncooperation that leaves everyone worse off is called a
prisoner's dilemma.
