INDIVIDUAL ASSIGNMENT 3

Question 1. Which of the following is not a characteristic of a competitive market?

a. Buyers and sellers are price takers.

b. Each firm sells a virtually identical product.

c. Free entry is limited.

d. Each firm chooses an output level that maximizes profits.

Question 2. When a firm has little ability to influence market prices it is said to be in
what kind of a market?.

a. a competitive market

b. a strategic

c. a thin market

d. a power market

Question 3. If a monopolist has zero marginal costs, it will produce?

a. the output at which total revenue is maximized.

b. in the range in which marginal revenue is still increasing.

c. at the point at which marginal revenue is at a maximum.

d. in the range in which marginal revenue is negative.

Question 4. For a monopolist, when the price effect is greater than the output effect,
marginal revenue is

a. positive.

b. negative.

c. zero.

d. maximized.
Question 5. What is the shape of the monopolist’s marginal revenue curve?

a. a downward-sloping line that is identical to the demand curve

b. a downward-sloping line that lies below the demand curve

c. a horizontal line that is identical to the demand curve

d. a horizontal line that lies below the demand curve

Question 6. Lala is a small tea company that is considering entering a market dominated
by Fresh. Each company’s profit depends on whether Lala enters and whether Fresh sets
a high price or a low price:

a. Does either player in this game have a dominant strategy?

b. Does your answer to part (a) help you figure out what the other player should do?

c. What is the Nash equilibrium? Is there only one?

d. Fresh threatens Lala by saying, “If you enter, we’re going to set a low price, so you
had better stay out.” Do you Lala should believe the threat? Why or why not?

e. If the two firms could collude and agree on how to split the total profits, what outcome
would they pick?
 ANSWER

a.

– Fresh has a dominant strategy of maintaining high prices. A strategy is said to be a

dominant strategy if it is the best strategy for one player to follow, regardless of the
strategy followed by other players.

+ If few Lala are involved, the major brewers will want to maintain high prices.

+ If few Lala do not enter, Fresh will want to maintain a high price. In other
words, big brew doesn't care about small Lala whether they enter or not. Fresh still wants
to maintain a high price.

 Therefore, Big Blue has a dominant strategy of maintaining a high price.

b.

- If Fresh maintains a high price, little Lala would enter.

- If Fresh maintained the low price, little Lala would not enter.

- Little Lala would not enter little corner does not have a dominant strategy in this case.

 My answer to part (a) has helped me figure out what other players should do.

c.

- Nash Equilibrium is a game theory concept that determines the optimal solution in a
non-cooperative game in which each player lacks any incentive to change his/her initial
strategy. Under the Nash equilibrium, a player does not gain anything from deviating
from their initially chosen strategy, assuming the other players also keep their strategies
unchanged. A game may include multiple Nash equilibria or none of them.

- Want Nash maintains a high price and little Lala enters a Nash equilibrium is a situation
in which economic actors interacting with one another all choose their best strategy,
given the strategies the other players have chosen because big brew has a dominant
strategy of maintaining a high price. Little Lala knows that Fresh will choose a high
price, regardless of whether it enters. Therefore, Little Lala will choose to enter because a
profit of two million is better than zero.

d.

- Little Lala should not believe this threat from Fresh because it is not in Fresh best
interest to carry out this threat.

- There is no upside for Fresh following through on a threat of lowering its price when it's
a dominant strategy. Regardless of whether little Lala enters the market is clear to
maintain a high price.

- So, if their dominant strategies are to maintain a high price, there's no reason to believe
a threat, telling us they're going to set a low price that contradicts itself.

- If little Lala enters, Fresh can set a high price, in which case it makes three million or
Fresh can set a low price, in which case it makes one million.

 Therefore, the threat is an empty one. Which little Lala should ignore, and little
Lala should enter the market.

e. Fresh maintains a high price and little Lala does not enter. If the two firms could
successfully collude, they would agree that big brute would maintain a high price and
little Lala would remain out of the market. They could then split a prop total profit of
seven million.