Microeconomics
Consider a market with two firms, Coke and Pepsi, that produce soft drinks. Both firms must choose whether to charge a high price ($1.25) or a low price ($0.75) for their soft drinks. These price strategies with corresponding profits are depicted in the payoff matrix to the right. Coke's profits are in red and Pepsi's are in blue. Coke's dominant strategy is to pick a price of $_________________ and Pepsi's dominant strategy is to pick a price of $_________________ What is the Nash equilibrium for this game?
$ .75 $.75 Coke and Pepsi will both choose a price of $.75
The figure to the right shows the market demand for electricity and the average total cost and marginal cost of producing electricity for a utility company. Suppose the utility company is a regulated natural monopoly. If government regulators want to achieve economic efficiency, then they will regulate a price of $nothing per kilowatt hour. (Enter a numeric response using a real number rounded to two decimal places.) ______________
$.16 Economic efficiency will be at the point where D=MC.
Now suppose instead that government regulators want to set the lowest price such that the utility company will not suffer a loss so that it will continue to produce in the long run. If so, then government regulators will set a price of ____________________ per kilowatt hour.
$.26 where D =ATC
The figure to the right illustrates the situation regarding a natural monopoly. If government regulators want to achieve economic efficiencyLOADING..., what price should they regulate? (Assume the natural monopoly produces at whatever price is regulated). If government regulators want to achieve economic efficiency, they should regulate a price of $__________ In the long run, will the natural monopoly produce at this regulated price? The natural monopoly will ________ to produce because at such a price, it would ____________ What price could government regulators set to maximize efficiency such that the firm would not experience losses? Government regulators should regulate a price of $ _____________
$1 not continue experience losses $2.50
Consider a market with two firms, Target and Wal-Mart, that sell CDs in their music department. Both stores must choose whether to charge a high price ($30) or a low price ($13) for the new Miley Cyrus CD. These price strategies with corresponding profits are depicted in the payoff matrix. Target's profits are in red and Wal-Mart's are in blue. Target's dominant strategy is to pick a price of $___________ Wal-Mart's dominant strategy is to pick a price of $__________ What is the Nash equilibrium for this game?
$13 $13 The Nash equilibrium is for Target and Wal-Mart to both choose a price of $13.
Consider a market with two firms, Target and Wal-Mart, that sell CDs in their music department. Both stores must choose whether to charge a high price ($25) or a low price ($17) for the new Miley Cyrus CD. These price strategies with corresponding profits are depicted in the payoff matrix. Target's profits are in red and Wal-Mart's are in blue. Target's dominant strategy is to pick a price of $ Wal-Mart's dominant strategy is to pick a price of $ What is the Nash equilibrium for this game?
$17 $17 The Nash equilibrium is for Target and Wal-Mart to both choose a price of $17
Consider a Caribbean cruise route served by two cruise lines, Carnival and Royal Caribbean. Both lines must choose whether to charge a high price ($290) or a low price ($270) to vacationers. These price strategies with corresponding profits are illustrated in the payoff matrix to the right. Carnival's profits are in red and Royal Caribbean's are in blue. Suppose the cruise lines decide to collude. At which outcome are joint profits maximized? Joint profits are maximized when Carnival picks $_____________ and Royal Caribbean picks $_________________ Is this outcome a Nash equilibrium? The cooperative equilibrium
$290 (high number) $290 (high number) is not a Nash equilibrium because Royal Caribbean can increase its profit by picking the low price. **One of the answers is not right!
Refer to the diagram to the right which shows cost and demand curves facing a typical firm in a constant−cost perfectly competitive industry. If the market price is $20, what is the amount of the firm's profit?
$6750 IN perfect competition, P = MCSo output is at 1,350AC at 1,350 is 15Profit = (20 - 15) x 1350 = 6,750
The graph shows a firm in a perfectly competitive market making a profit. The graph includes the firm's marginal cost curve, average total cost curve, and average variable cost curve. Assume the market price is $34.
...
Video Question : 1) If Wal-Mart charges $400, how much should Target charge? 2) If Wal-Mart charges $300, how much should Target charge? 3) Does Target have a dominant strategy? If so, what is it? 4) If Target charges $400, how much should Wal-Mart charge? 5) If Target charges $300, how much should Wal-Mart charge? 6) Does Wal-Mart have a dominant strategy? If so, what is it?
1. Target should charge $300 2. Target should charge $300 3.Target is best off to charge $300. Because regardless if Walmart charges $400 or if they charge $300, Target is better off to charge $300. This is their dominant strategy 4.Walmart should charge $300 5. Walmart should charge $300 6. They have a dominant strategy for charging $300.
The graph to the right depicts the demand for electricity from a local utility along with the average total cost and marginal cost of producing electricity. Suppose the local utility is a monopoly. What is the profit-maximizing quantity of electricity? nothing million kilowatt hours per day. (Enter a numeric response using an integer.) ___________ What is the corresponding profit-maximizing price? $. 64.64 per kilowatt hour. (Enter a numeric response using a real number rounded to two decimal places.) ________________ Calculate the local utility's profits. $1.81.8 million per day. (Enter a numeric response using a real number rounded to two decimal places.) ___________
30 $.64 $1.8 .64-.58 x 30 = 1.8
the graph to the right depicts the demand for caffe lattes at a local coffeehouse along with the average total cost and marginal cost of producing lattes. Suppose the coffeehouse is in a monopolistically competitive market in the short run. How many caffe lattes should this coffeehouse produce to maximize profits? ____________ units What is the corresponding profit-maximizing price? $___________ Calculate the coffeehouse's profits on caffe lattes. $ ______________
34 units $2.4 $7.48
Monopoly
A firm that is the only seller of a good or service that does not have a close substitute.
The Herfindahl-Hirschman Index (HHI):
A market is concentrated if a relatively small number of firms have a large share of total sales in the market. Therefore, higher HHI values correspond to greater market concentration.
Oligopooly
A market structure in which a small number of interdependent firms compete. However, new firms will enter industries when existing firms are earning economic profits.
Dominant strategy
A strategy that is the best for a firm, no matter what strategies other firms use.
Alpha and Beta are the only firms selling gyros in the upscale town of Delphi. Each firm must decide on whether to offer a discount to students to compete for customers. If one firm offers a discount but the other does not, then the firm that offers the discount will increase its profit. The figure shows the payoff matrix for this game. If Alpha assumes that Beta would offer a student discount, what should it do?
Alpha should also offer a student discount.
Cooperative equilibrium
An equilibrium in a game in which players cooperate to increase their mutual payoff.
What is the Nash equilibrium for this game?
BP will advertise and the Mini-Mart will not advertise.
Suppose Best Buy is the only electronics store in a particular market, but RadioShack is thinking about entering the market. Best Buy chooses how much to produce first and then RadioShack chooses whether to enter the industry. The strategies and corresponding profits for Best Buy (BB) and RadioShack (RS) are depicted in the decision tree to the right. What will the firms do?
Best Buy will choose the large quantity and RadioShack will not enter. BB will choose to producer large quantity even when it can earn higher profit by producing small quantity. This is done to restrict the entry of RS in the market. If RS enters the market when BB produces large quantity then it has to suffer loss of $ 14 so RS will not enter and be at no profit no loss situation. After sometime, when RS does not enter, BB increases its profit by producing small quantity.
What is perfect price discrimination?
Charging every consumer a different price equal to their willingness to pay.
Refer to the diagram to the right. What is the amount of excess capacity?
Q4−Q2 units
Suppose a market has twenty firms, each with 5% market share. What is the Herfindahl-Hirschman Index (HHI) of concentration for this market?
The HHI is 500 HHI = 20- x 5^2 HHI = 20 x 25 HHI = 500
What is the Nash equilibrium for this game?
The Nash equilibrium is for Saudi Arabia to produce a high output and Kuwait to produce a high output. ***The Nash equilibrium is for Saudi Arabia to produce a low output and Kuwait to produce a high output. Best Response for Saudi Arabia BRs(Low) = Low BRs(High) = High Best Response for Kuwait BRK(Low) = High BRK(High) = High The nash equilibrium is (High, High)
Consider a market with two firms, Kellogg and Post, that sell breakfast cereals. Both companies must choose whether to charge a high price ($4.00) or a low price ($2.50) for their cereals. These price strategies, with corresponding profits, are depicted in the payoff matrix to the right. Kellogg's profits are in red and Post's are in blue. What is the cooperative equilibrium for this game?
The cooperative equilibrium is for Kellogg and Post to both choose a price of $4.00.
Consider the market for oil. Suppose for simplicity that there are only two oil producing countries—Saudi Arabia and Kuwait. Both countries must choose whether to produce a low output or a high output. These output strategies with corresponding profits are depicted in the payoff matrix. Kuwait's profits are in red and Saudi Arabia's are in blue. Suppose the two countries form a cartel. What is the cooperative equilibrium
The cooperative equilibrium is for Saudi Arabia to produce a low output and Kuwait to produce a high output. ***The cooperative equilibrium is for Saudi Arabia to produce a low output and Kuwait to produce a low output.
For a natural monopoly to exist
a firm's long-run average cost curve must exhibit economies of scale throughout the relevant range of market demand.
A dominant strategy is
a strategy that is the best for a firm no matter what strategies other firms use.
Baxter International, a manufacturer of hospital supplies, acquired American Hospital Supply, a distributor of hospital supplies. This is an example of
a vertical merger.
Bradford is a small town that currently has no fast-food restaurants. McDonald's and Burger King are both considering entering this market. Burger King will wait until McDonald's has made its decision before deciding whether to enter. Use the decision tree below to determine the optimal strategy for each company, assuming that the minimum rate of return that owners of fast-food restaurants require on their investment is 15%. a. What is the optimal strategy for Burger King? b. What is the optimal strategy for McDonald's?
a. enter the market whether or not McDonalds builds a small store or a large store b. build a small store
The economic analysis of monopolistic competition shows that market forces eliminate profits in the long run. However, it is possible for a firm to continue to earn economic profits if the firm
adopts new technologies that enable it to lower its cost of production.
A town has two gas stations, BP and the Mini-Mart (MM). The gas stations must choose whether to advertise their gasoline. The advertising strategies with corresponding profits are illustrated in the payoff matrix to the right. BP's profits are in red and the Mini-Mart's are in blue. What is each firm's dominant strategy? BP's dominant strategy is to ______________ and the Mini-Mart's dominant strategy is to _________________
advertise not advertise
Suppose a local McDonald's hamburger restaurant raises the price of its cheeseburgers from $2.00 to $2.50. What will happen to the quantity of McDonald's cheeseburgers demanded? If McDonald's raises the price of it's cheeseburgers, then
all of McDonald's customers will continue to demand McDonald's cheeseburgers because cheeseburgers from other fast-food restaurants are at least slightly differentiated.
barrier to entry
anything that keeps new firms from entering an industry in which firms are earning economic profits.
Are monopolistically competitive firms efficient in long-run equilibrium? Monopolistically competitive firms
are not productively efficient because they do not produce at minimum average total cost and they are not allocatively efficient because they produce where price is greater than marginal cost.
Refer to the diagram to the right. Compared to a perfectly competitive market, consumer surplus is lower in a monopoly by an amount equal to the
area P1P2EF.
Refer to the diagram to the right which shows cost and demand curves facing a profit−maximizing perfectly competitive firm. Identify the short run shut down point for the firm.
b
Why do oligopolies exist?
barriers to entry
What is the difference between a horizontal merger and a vertical merger? A horizontal merger is a merger
between firms in the same industry, while a vertical merger is a merger between firms at different stages of the production of a good.
If a firm could practice perfect price discrimination, it would
charge every buyer a different price.
An agreement among firms to charge the same price or otherwise not to compete is called
collusion.
How are decision trees used to analyze sequential games? A decision tree
contains decision nodes where firms must make decisions, arrows illustrating the decisions, and terminal nodes showing the resulting rates of return.
What happens if a perfectly competitive industry becomes a monopoly? Suppose the demand curve in the figure is market demand and the corresponding market supply curve represents the marginal cost of production. Compared to perfect competition, a profit-maximizing monopoly would ___________ output by _______________ units In addition, a monopoly would ______________ price by ___________
decrease ..... by 2 6 - 4 = 2 lower......$2
What is "natural" about a natural monopoly? A natural monopoly
develops automatically due to diseconomies of scale.
Profitability is partially determined by the firm's ability to create value for its customers. How can a firm create this type of value? Firms can create value for their customers by
differentiating their product from competing products
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.
Is perfect price discrimination economically efficient? Perfect price discrimination is
efficient because it converts into producer surplus what had been consumer surplus and deadweight loss.
The graph depicts the demand (and marginal revenue) for a monopolistically competitive firm's shampoo along with the average total cost and marginal cost of producing shampoo in the short run. As the market for shampoo moves toward a long-run equilibrium, firms will ________ the industry this will shift the demand curves for existing firms to the ________ and the demand curves of existing firms will become _________ elastic
exit right less
What are the most important differences between perfectly competitive markets and monopolistically competitive markets? Unlike in perfectly competitive markets, in monopolistically competitive markets,
firms face downward-sloping demand curves, and the products competitors sell are differentiated.
Higher HHI values correspond to _______________ market concentration
greater
A profit maximizing monopoly's price is
greater than the price that would prevail if the industry is perfectly competitive.
Which type of merger is more likely to increase the market power of a newly merged firm? ________________________ mergers are more likely to increase market power.
horizontal
A perfectly competitive firm faces a demand curve that is
horizontal.
A characteristic found only in oligopolies is
interdependence of firms.
Describe a monopoly's demand curve. A monopoly's demand curve
is the same as the demand curve for the product.
Is the cooperative equilibrium likely to occur? The cooperative equilibrium
is unlikely to occur because charging $4.00 is not a dominant strategy.
If a perfectly competitive firm achieves productive efficiency then
it is producing the good it sells at the lowest possible cost.
If a firm faces a downward-sloping demand curve
it must reduce its price to sell more units
The firm's short−run supply curve is its
marginal cost curve from c and above.
For a perfectly competitive firm, at profit maximization
marginal revenue equals marginal cost
Is zero economic profit inevitable in the long run for monopolistically competitive firms? In the long run, monopolistically competitive firms
may continue to earn profit by reducing costs.
How do barriers to entry affect 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.
The figure shows the cost and demand curves for a monopolist. The profit−maximizing output and price for the monopolist are
output = 62; price = $18.
When a monopolistically competitive firm cuts its price to increase its sales, it experiences a loss in revenue due to the
price effect.
Suppose the market for fast-food value meals is monopolistically competitive, with many restaurants selling their own brand of food. Assume the restaurants in the industry behave optimally by maximizing profit. The figure represents the market for one monopolistically competitive firm's value meals. How will this figure change as the market moves toward long-run equilibrium? In the long run,
the demand curve will shift to the left and become more elastic because the firms are currently making profit.
Why might a monopoly arise? One firm will be present when
the government blocks entry of more than one firm by granting a copyright
For a perfectly competitive firm, average revenue is equal to
the market price
Refer to the diagram to the right. Suppose the prevailing price is $20 and the firm is currently producing 1,350 units. In the long run equilibrium,
there will be fewer firms in the industry but total industry output increases.
Perfect price discrimination is
unlikely to occur because firms typically do not know how much each consumer is willing to pay.
Give two examples of products sold in perfectly competitive markets and two examples of products sold in monopolistically competitive markets.
wheat and corn are sold in perfectly competitive markets and Starbucks coffee and Gap clothing are sold in monopolistically competitive markets. Apples and oranges are sold in perfectly competitive markets and Maybelline cosmetics and Ralph Lauren cologne are sold in monopolistically competitive markets.
What is an oligopoly? An oligopoly is a market structure
where a small number of interdependent firms compete.
What is a sequential game? A sequential game is a game
where one firm acts first and then the other firms respond.
If the demand curve for a firm is downward - sloping, its marginal revenue curve
will lie below the demand curve.
Is a monopolistically competitive firm productively efficient?
No, because it does not produce at minimum average total cost.
Alpha and Beta are the only firms selling gyros in the upscale town of Delphi. Each firm must decide on whether to offer a discount to students to compete for customers. If one firm offers a discount but the other does not, then the firm that offers the discount will increase its profit. The figure shows the payoff matrix for this game. Does Alpha have a dominant strategy and if so, what is it?
Yes, Alpha should offer a student discount.
Assume that Lexus (L) is the first automobile company to produce a luxury class hybrid automobile and is the only such company for the past four years. BMW is now considering producing its own luxury hybrid automobile and Lexus must decide whether or not to lower the price of its luxury hybrid to counter BMW's entry into the luxury hybrid niche. Refer to the decision tree above. Should Lexus lower its price in order to deter BMW's entry into the luxury hybrid automobile market?
Yes, it will drive BMW out of the market.
The figure shows the payoff matrix for Walmart and Target from every combination of pricing strategies for the popular PlayStation 4. At the start of the game each firm charges a low price and each earns a profit of $7,000. Is the current strategy in which each firm charges the low price and earns a profit of $7,000 a Nash equilibrium? If not, why and what is the Nash equilibrium?
Yes, the current situation is a Nash equilibrium.
Three examples of oligopolies in the United States are industries that produce or sell
computers ,athletic footware, and cigarettes.
