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)