Practice problem set 5

Managerial Economics
PGP – 1: Term 1, Section A, 2019-2020
Scenario 13.3
Consider the following game:

1) Which of the following is true for the game in Scenario 13.3?

A) Moto's dominant strategy is the CD changer.
B) Moto's dominant strategy is the free maintenance.
C) Zport's dominant strategy is the low-profile tires.
D) Zport's dominant strategy is the sun roof.
E) Neither company has a dominant strategy.

2) In the game in Scenario 13.3, the equilibrium outcome:

A) is for Moto to offer a CD changer and Zport to offer low-profile tires.
B) is for Moto to offer a CD changer and Zport to offer a sun roof.
C) is for Moto to offer free maintenance and Zport to offer low-profile tires.
D) is for Moto to offer free maintenance and Zport to offer a sunroof.
E) does not exist in pure strategies.

3) Nash equilibria are stable because

A) they involve dominant strategies.
B) they involve constant-sum games.
C) they occur in noncooperative games.
D) once the strategies are chosen, no players have an incentive to negotiate jointly to change
them.
E) once the strategies are chosen, no player has an incentive to deviate unilaterally from
them.

Scenario 13.7:
Consider the game below about funding and construction of a dam to protect a 1,000-person
town. Contributions to the Dam Fund, once made, cannot be recovered, and all citizens
must contribute $1,000 to the dam in order for it to be built. The dam, if built, is worth
$70,000 to each citizen.

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Each of

4) In the game in Scenario 13.7, the strategy pair that pays

A) $69,000 to each player is the only equilibrium.
B) ($0, -$1000) is the only equilibrium.
C) (-$1000, $0) is the only equilibrium.
D) $0 to each player is the only equilibrium.
E) $69,000 to each player and the strategy pair that pays $0 to each player are equilibria.

Scenario 13.11
Consider the game below:

5) What is true about dominant strategies in the game in Scenario 13.11?

A) R1 and C1 are dominant strategies.
B) R1 and C2 are dominant strategies.
C) R2 and C1 are dominant strategies.
D) R2 and C2 are dominant strategies.
E) There are no dominant strategies.

6) In the game in Scenario 13.11, equilibrium is

A) R1, C1.
B) R1, C2.
C) R2, C1.
D) R2, C2.
E) a mixed strategy based on all four pure strategies.

7) Consider the following output-choice game for two firms:

Firm 2 - low Firm 2 - medium Firm 2 - high

Firm 1 - low 150, 150 100, 160 75, 100
Firm 1 - medium 160, 100 110, 110 50, 75
Firm 1 - high 100, 75 75, 50 0, 0

What is Firm 2's first-mover advantage in a sequential game relative to a simultaneous

game?
A) Zero
B) 40

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C) 50
D) 110

Scenario 13.9
Consider the following game:

Two firms are situated next to a lake, and it costs each firm $1,500 per period to use filters
that avoid polluting the lake. However, each firm must use the lake's water in production, so
it is also costly to have a polluted lake. The cost to each firm of dealing with water from a
polluted lake is $1,000 times the number of polluting firms.

8) Refer to Scenario 13.9. If this game is repeated over an infinite or uncertain horizon, the
most likely observed behavior will be that (assume a time discount factor of 0.05)
A) both firms pollute.
B) only Lago pollutes.
C) only Nessie pollutes.
D) neither firm pollutes.
E) the firms alternate polluting in different periods.

9) In comparing the Cournot equilibrium with the competitive equilibrium,

A) both profit and output level are higher in Cournot.
B) both profit and output level are higher in the competitive equilibrium.
C) profit is higher, and output level is lower in the competitive equilibrium.
D) profit is higher, and output level is lower in Cournot.

10) A ________ shows how much a firm will produce as a function of how much it thinks its
competitors will produce.
A) contract curve
B) demand curve
C) reaction curve
D) Nash equilibrium curve
E) none of the above

11) What is one difference between the Cournot and Stackelberg models?
A) In Cournot, both firms make output decisions simultaneously, and in Stackelberg, one firm
sets its output level first.
B) In Stackelberg, both firms make output decisions simultaneously, and in Cournot, one firm
sets its output level first.
C) In Cournot, a firm has the opportunity to react to its rival.
D) Profits are zero in Cournot and positive in Stackelberg.

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12) The oligopoly model that is most appropriate when one large firm usually takes the lead
in setting price is the ________ model.
A) Cournot
B) Stackelberg
C) non-game theory
D) prisoner's dilemma

13) In a Cournot duopoly, we find that Firm 1's reaction function is Q1 = 50 - 0.5Q2, and Firm
2's reaction function is Q2 = 75 - 0.75Q1. What is the Cournot equilibrium outcome in this
market?
A) Q1 = 20 and Q2 = 60
B) Q1 = 20 and Q2 = 20
C) Q1 = 60 and Q2 = 60
D) Q1 = 60 and Q2 = 20

14) In the Stackelberg model, suppose the first-mover has MR = 15 - Q1, the second firm has
reaction function Q2 = 15 - Q1/2, and production occurs at zero marginal cost. Why doesn't
the first-mover announce that its production is Q1 = 30 in order to exclude the second firm
from the market (i.e., Q2 = 0 in this case)?
A) In this case, MR is negative and is less than MC, so the first-mover would be producing
less than the optimal quantity.
B) In this case, MR is negative and is less than MC, so the first-mover would be producing too
much output.
C) This is a possible outcome from the Stackelberg duopoly under these conditions.
D) We do not have enough information to determine if this is an optimal outcome for this
case.

Scenario 12.3:
Suppose a stream is discovered whose water has remarkable healing powers. You decide to
bottle the liquid and sell it. The market demand curve is linear and is given as follows:
P = 30 - Q
The marginal cost to produce this new drink is $3.

15) Refer to Scenario 12.3. What will be the price of this new drink in the long run if the
industry is a Bertrand duopoly?
A) $3
B) $9
C) $12
D) $13.50
E) none of the above

16) Suppose two firms with differentiated products are competing on price. The reaction
curve for Firm 1 is P1 = 4 + 0.5 P2, and the reaction curve for Firm 2 is P2 = 4 + 0.5P1. What is
the equilibrium price outcome in this market?
A) P1 = P2 = 4

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B) P1 = P2 = 6
C) P1 = P2 = 8
D) P1 = 6 and P2 = 8
Short answer question

17) Two firms at the St. Louis airport have franchises to carry passengers to and from hotels
in downtown St. Louis. These two firms, Metro Limo and Urban Limo, operate nine
passenger vans. These duopolists cannot compete with price, but they can compete through
advertising. Their payoff matrix is below:

a. Does each firm have a dominant strategy? If so, explain and what that strategy is.
b. What is the Nash equilibrium? Explain where the Nash equilibrium occurs in the payoff
matrix.

18) Joanna has a credit card account with Card Bank. Card Bank's available strategies are to
raise Joanna's credit card interest rate or do nothing. Joanna's available strategies are to
transfer her Card Bank account balance to another creditor or do nothing. If Card Bank
raises Joanna's interest rate and Joanna does nothing, Card Bank increases profits by $1,000
while Joanna receives -$1,000. If Card Bank raises Joanna's interest rate and Joanna transfers
her account to another creditor, Card Bank receives -$300 while Joanna receives -$100. If
Card Bank does nothing and Joanna does nothing, each player receives $0. If Card Bank
does nothing and Joanna transfers her account to another creditor, Card Bank receives -$300
while Joanna receives -$150. Diagram the game tree for this sequential game. Indicate any
Nash equilibria.

19) Suppose that the market demand for mountain spring water is given as follows:
P = 1200 - Q
Mountain spring water can be produced at no cost.

What level of output would be produced by each firm in a Cournot duopoly? What will the
price be?

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20) Lambert-Rogers Company is a manufacturer of petrochemical products. The firm's
research efforts have resulted in the development of a new auto fuel injector cleaner that is
considerably more effective than other products on the market. Another firm, G.H. Squires
Company, independently developed a very similar product that is as effective as the Lambert-
Rogers formula. To avoid a lengthy court battle over conflicting patent claims, the two firms
have decided to cross-license each other's patents and proceed with production. It is unlikely
that other petrochemical companies will be able to duplicate the product, making the market
a duopoly for the foreseeable future. Lambert-Rogers estimates the demand curve given
below for the new cleaner. Marginal cost is estimated to be a constant $2 per bottle.
Q = 300,000 - 25,000P.
where P = dollars per bottle and Q = monthly sales in bottles.

a. Lambert-Rogers and G.H. Squires have very similar operating strategies. Consequently,
the management of Lambert-Rogers believes that the Cournot model is appropriate for
analyzing the market, provided that both firms enter at the same time. Calculate Lambert-
Rogers's profit-maximizing output and price according to this model.
b. Lambert-Rogers's productive capacity and technical expertise could allow them to enter
the market several months before Squires's. Choose an appropriate model and analyze the
impact of Lambert Rogers being first into the market. Should Lambert-Rogers hurry to enter
first?

21) Hale's One Stop and Auto Service competes with Murray's Gas Mart. The local demand
is:
Qd = 25 - 10P ⇔ P = 2.50 - 0.1 Qd. Both firms sell exactly the same quality of gasoline. Thus,
if the firms charge a different price, the lower price firm will capture the entire market share.
If the firms charge the same price, they will split the market share. The marginal cost functions
are both constant at $1.25. If the firms compete by setting price, what is the market output
level? What is the market price level?