Economics
101
Fall
2001
Answer
Key to Practice Questions 8
Question
1
(a)
|
Pepsi |
|
|
Advertise |
Don't |
||
Coke |
Advertise |
8,8 |
18,0 |
|
Don't |
0,18 |
10,10 |
(b)
(Do
Advertise, Do Advertise) is the equilibrium.
Question
2
(a)
If
Microsoft and IBM collude, they will charge the monopoly price and split the
production of the output.
P = $10, Q = 12 à Each firm produces 6
Note: Since
there are no fixed costs and marginal cost is constant, the total cost = 4Q
Profits per store = TR – TC = $36
(b)
If
one firm decides to undercut their competitor and cheat on the deal and charge
one dollar less, they can grab the entire market since customers go to the
lowest cost firm. To find the quantity
that the cheating firm would sell if they charged one dollar less, plug $9 into
the demand function to find out what the firm will sell:
QD = 32 – 2(9) = 14
Profits = $70
So, if the firm knows that his competitor will stay with the collusive agreement, then the firm has an incentive to undercut the price by one dollar and grab the entire market.
If both firms decide to charge $1 less, they split
the output since they are charging the same price. If they both cheat, profits = $35.
|
|
IBM |
|
Microsoft |
|
Collude |
Cheat |
|
Collude |
36,36 |
0,70 |
|
Cheat |
70,0 |
35,35 |
(c)
The
equilibrium is for both firms to
cheat. Both firms can agree to collude
and fix the price at the joint profit-maximizing price, $10. However, both firms have the incentive to undercut
the price of the competitor. In that
case, both firms will cheat.
Question
3
(a)
The
dominant strategy for player 1 is Up while player 2 has no dominant strategy.
(b)
The
dominant strategy for player 1 is Down while player 2’s dominant strategy is
Middle.
Question
4
The
equilibrium location for the ice cream
vendors has to be an outcome that would have neither vendor wanting to switch
their location once they have chosen their spot. Assume that the vendors choose to locate on the extreme endpoints
of the beach, Ice Dream on the right and Yogurt Express on the left. Since sunbathers go to the closest ice cream
vendor, Ice Dream can move closer to the middle and steal customers from Yogurt
Express. Yogurt Express realizes that
Ice Dream is stealing its customers, and moves closer to the middle, also. Eventually, both ice cream vendors will end
up in the middle, where neither has the incentive to deviate (move from their
location).
Question
5
(a)
The
equilibrium outcome will be for both
boy bands to price at marginal cost (p = $15).
To see why this is true, assume that they set a price above $15, let’s
assume at $20. The Boyz will realize
they can grab the entire love song
market by charging $19. N’Stink
attempts to grab the entire market back by pricing at $18. The price cuts will continue until they both
hit $15.
(b)
Now
that N’Stink has a lower marginal cost, they can have control over the entire love song market. The lowest price that the Boyz can charge is p = $20 (their
marginal cost). N’Stink can easily
undercut the Boyz’s price by charging slightly lower price, such as $19.99 –
effectively driving their rival band out of the market. So the Equilibrium set of prices is for N’Stink to charge P = $19.99 and
the boyz can charge any price (doesn’t matter what price they charge since they
are priced out of the market).
Multiple
Choice
1.
(A)
2.
(A)
3.
(D)
4.
(A)
5.
(B)
6.
(E)