Economics 215: Principles of Microeconomics
Dr. Stonebraker
Answers to Problem Set #16
Answers to chapter 10 concept problem:
6.
It’s possible that they trust their students not to cheat. More likely though they realize that
one or more students will engage in strategic behavior and cheat on any agreements reached
among members of the class. Each student would have a strong incentive to try to
outperform the rest of the class. Cheating on the agreement would be a dominant strategy
for each student.
Answers to chapter 10 numerical problem:
4a. Firm A has a dominant strategy of expanding advertising. Its payoff from this strategy is
greater regardless of the strategy chosen by Firm B.
4b. Firm B also has a dominant strategy of expanding advertising. Its payoff from that strategy
is greater regardless of the strategy chosen by Firm A.
4c. Because both firms have a dominant strategy, there is a dominant strategy equilibrium of
expanding advertising.
Answers to other questions;
1a. Alpha has a dominant strategy of Y. If Beta chooses strategy X, Alpha will earn either 30
(with strategy X) or 40 (with strategy Y). If Beta chooses strategy Y, Alpha will earn either
75 (by choosing X) or 95 (by choosing Y). In both cases, Alpha is better off choosing
strategy Y. Similarly, Beta has a dominant strategy of X. If Alpha chooses X, Beta will
earn either 90 (with X) or 40 (with Y). If Alpha chooses Y, Beta will earn either 50 (with
X) or 30 (with Y). Strategy X is better for Beta in each case.
1b. If Alpha chooses Y and Beta chooses X, both are using their dominant strategies and neither
has any incentive to change. Thus, this combination is a Nash Equilibrium. Note that this
equilibrium does not maximize joint gains.
2. If one oligopolist cuts its price to get more customers, the other oligopolists can follow suit
and cut their prices as well to protect their market share. Therefore, oligopolists rarely get
any long-term advantage from changing prices. To get a long-term edge over rivals, an
oligopolist needs a strategy that its rivals cannot easily duplicate. Because successful
advertising campaigns and/or new product innovations are more difficult for rivals to copy,
they offer more possibilities for long-run profit.
3. To keep the cartel price high, members must voluntarily restrict output. However, while the
group wants to restrict output, each individual firm wants to expand its output. Because the
cartel price exceeds MC, each individual firm has an incentive to expand output -- the
additional revenue of another sale will exceed the MC. Eventually some member of the
cartel will offer secret price concessions to get these additional, profitable sales. When other
firms lose customers to the "cheating" firm, they have an incentive to cut prices as well.
Soon a price war breaks out and the cartel collapses.
Cartels are most likely to be successful when the number of producers is small and entry
barriers are high, when demands are relatively inelastic, and when cheating firms can be
easily detected and punished.