11 Practice Problems Oligopoly

UNIVERSITY OF TORONTO ECO100: INTRODUCTORY ECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD
PRACTICE PROBLEMS
OLIGOPOLY
1. The fact that the price effect for an oligopolist is less than the price effect for a monopolist helps explain
why firms are likely to cheat on a cartel agreement.
A) True
B) False
2. (Table: Two Rival Gas Stations) Look at the table Two Rival Gas Stations. Swifty Gas and Speedy Gas
are the only two gas stations in a small town. Each firm can set either a high price or a low price, and
customers view these two firms as nearly perfect substitutes. The table shows the payoff matrix of
daily profits that each firm would receive from its pricing decision, given the pricing decision of its
rival. Profits in each cell of the payoff matrix are given as (Swifty, Speedy). Which of the following
choices describes a dominant strategy?
A) Swifty will always set a low price, no matter Speedy's choice.
B) Swifty will always set a high price, no matter Speedy's choice.
C) Swifty will set a low price when Speedy sets a high price, but Swifty will set a high price when Speedy
sets a low price.
D) Swifty will set a high price when Speedy sets a high price, but Swifty will set a low price when Speedy
sets a low price.
3. (Table: Two Rival Gas Stations) Look at the table Two Rival Gas Stations. Swifty Gas and Speedy Gas
are the only two gas stations in a small town. Each firm can set either a high price or a low price, and
customers view these two firms as nearly perfect substitutes. The table shows the payoff matrix of
daily profits that each firm would receive from its pricing decision, given the pricing decision of its
rival. Profits in each cell of the payoff matrix are given as (Swifty, Speedy). If each firm sets the price
independently, the Nash equilibrium outcome will be:
A) $100, $100.
B) $150, $25.
C) $25, $150.
D) $50, $50.
4. In the classic prisoners' dilemma with two accomplices in crime, the Nash equilibrium is for:
A) neither to confess.
B) both to confess.
C) one to confess and the other not to confess.
D) This game does not have a Nash equilibrium.
5. Oligopolists will earn zero profits unless they can collude.

A) True
B) False
201211 1 PRACTICE PROBLEMS: OLIGOPOLY

6. Two large electronic retailers, Biggest Buy and Connection City, are considering entering a small town.
Each firm can either enter the market or not. The table shows the payoff matrix of daily profits that
each firm would receive from its entry decision, given the entry decision of its rival. Profits in each cell
of the payoff matrix are given as (Biggest Buy, Connection City). Are there any dominant strategies in
the game? If this game is played only once and each firm makes the entry decision independently, what
is the Nash equilibrium of this game? Explain your conclusions.
7. Both monopolists and cartel members will find that a drop in price leads to:
A) a quantity effect that negatively affects total revenue.
B) a price effect that negatively affects total revenue.
C) a quantity effect that has no effect on total revenue.
D) neither a price nor a quantity effect occurring in such markets.
Figure: Payoff Matrix I for Blue Spring and Purple Rain
8. (Figure: Payoff Matrix I for Blue Spring and Purple Rain) The figure Payoff Matrix I for Blue Spring and
Purple Rain refers to two producers of bottled water. Each has two strategies available to it: a high
price and a low price. The dominant strategy for Purple Rain is to:
A) always charge a low price.
B) always charge a high price.
C) always adopt the same strategy as Blue Spring.
D) Purple Rain does not have a dominant strategy.

9. (Table: Demand for Solar Water Heaters) Look at the table Demand for Solar Water Heaters. The
marginal cost of producing solar water heaters is zero, and only two firms, Rheem and Calefi, produce
them. If they agree to collude, what price will the cartel charge and how many water heaters will the
cartel sell?
A) $1,000; 50
B) $1,100; 45
C) $900; 55
D) $800; 60
them. If they agree to produce only 50 water heaters, with each firm producing only 25, by how much
does Rheem's profit rise if it cheats on the agreement and produces 30 water heaters?
A) $3,000
B) $2,700
C) $2,000
D) $5,000
them. If they agree to produce only 50 water heaters, with each firm producing only 25 and if Rheem
cheats on the agreement and produces 30 water heaters, what is the price effect?
A) –$1,000
B) –$2,500
C) $2,000
D) $1,000
12. Which of the following scenarios best describes an oligopolistic industry?

A) A single cable company serves customers in a small town.
B) Thousands of soybean farmers sell their output in a global commodities market.
C) Coca-Cola and Pepsi sell most of the soft drinks consumed around the world.
D) A college has one bookstore selling textbooks to students.
13. Airlines are prone to price wars because:

A) most fliers choose airlines on the basis of schedule and price.
B) airline pricing is easy to understand.
C) airlines have the same costs.
D) airlines operate close to capacity.
Scenario: Two Identical Firms

Two identical firms make up an industry in which the market demand curve is represented by Q =
5,000 – 4P, where Q is the quantity demanded and P is price per unit. The marginal cost of producing
the good in this industry is constant and equal to $650.
14. (Scenario: Two Identical Firms) When the firms in the scenario Two Identical Firms collude and
produce the profit-maximizing output, what is the profit earned by each firm?
A) $360,000
B) $180,000
C) $15,000
D) $25,000
15. (Scenario: Two Identical Firms) Suppose the two firms in the scenario Two Identical Firms decide to
cooperate and collude, resulting in the same amount of production for each firm. What is the profit-
maximizing price and output for the industry?
A) P = $400; Q = 5,000 units.
B) P = $950; Q = 1,200 units.
C) P = $600; Q = 1,500 units.
D) P = $300; Q = 2,000 units.
16. Which of the following is most likely to be observed when firms engage mainly in non-price
competition?
A) actively encouraging the sale of generic as opposed to brand-name products
B) advertising and product differentiation
C) discounts offered through coupons
D) low interest rates for financing the purchase of big-ticket items
Figure: Payoff Matrix for Gehrig and Gabriel
17. (Figure: Payoff Matrix for Gehrig and Gabriel) The figure Payoff Matrix for Gehrig and Gabriel refers
to two people who sell handmade Davy Crockett figurines in San Antonio. Both Gehrig and Gabriel
have two strategies available to them: to produce 5,000 figurines each month or to produce 7,000
figurines each month. If both follow a tit-for-tat strategy, equilibrium will be reached when:
A) each produces 5,000 figurines.
B) each produces 7,000 figurines.
C) Gehrig produces 7,000 figurines and Gabriel produces 5,000 figurines.
D) Gehrig produces 5,000 figurines and Gabriel produces 7,000 figurines.
18. (Figure: Payoff Matrix for Gehrig and Gabriel) The figure Payoff Matrix for Gehrig and Gabriel refers
to two people who sell handmade Davy Crockett figurines in San Antonio. Both Gehrig and Gabriel
have two strategies available to them: to produce 5,000 figurines each month or to produce 7,000
figurines each month. For Gehrig and Gabriel, the dominant strategy is to:
A) produce 5,000 figurines.
B) produce 7,000 figurines.
C) produce between 5,000 and 7,000 figurines.
D) collude and increase production to more than 14,000 figurines.
19. The noncooperative equilibrium of a prisoners' dilemma kind of game can be avoided if the game is
played repeatedly and firms engage in strategic behavior.
A) True
B) False

20. Gary's Gas and Frank's Fuel are the only two providers of gasoline in their small town. Gary and Frank
decide to form a cartel to raise the price of gasoline. The total industry profits are highest when
________, and Gary's profits are highest when ________.
A) neither firm cheats on the agreement; neither firm cheats on the agreement
B) neither firm cheats on the agreement; Gary cheats on the agreement and Frank does not cheat
C) both firms cheat on the agreement; Gary cheats on the agreement and Frank does not cheat
D) both Gary and Frank cheat on the agreement; both Gary and Frank cheat on the agreement
21. Which of the following characteristics make an industry more conducive to collusive behavior?
A) Firms in the industry have very different marginal costs of production.
B) Firms in the industry produce goods with significantly different product attributes.
C) Firms are operating at a maximum productive capacity that cannot be easily altered in the short run.
D) Customers can easily switch between firms as they search for the best price.
Figure: Payoff Matrix II for Blue Spring and Purple Rain
22. (Figure: Payoff Matrix II for Blue Spring and Purple Rain) Payoff Matrix II for Blue Spring and Purple
Rain refers to two producers of bottled water. The Nash equilibrium in the figure is reached when:
A) both firms charge a high price.
B) both firms charge a low price.
C) Blue Spring charges a high price and Purple Rain charges a low price.
D) Purple Rain charges a high price and Blue Spring charges a low price.
Figure: Payoff Matrix for the United States and the European Union
23. (Figure: Payoff Matrix for the United States and the European Union) Look at the figure Payoff Matrix
for the United States and the European Union. Suppose that the United States and the European
Union both produce corn, and each region can make more profit if output is limited and the price of
corn is high. If either regions increase their output of corn, the profits of both are affected as shown in

the payoff matrix. The Nash equilibrium combination is for:

A) both the United States and the European Union to produce a high output.
B) the United States to produce a high output and the European Union to produce a low output.
C) both the United States and the European Union to produce a low output.
D) the European Union to produce a high output and the United States to produce a low output.
24. (Figure: Payoff Matrix for the United States and the European Union) Look at the figure Payoff Matrix
for the United States and the European Union. Suppose that the United States and the European
Union both produce corn, and each region can make more profit if output is limited and the price of
corn is high. If either region increases its output of corn, the profits of both are affected as shown in
the payoff matrix. The optimal combination is for:
A) both the United States and the European Union to produce a high output.
B) the United States to produce a high output and the European Union to produce a low output.
C) both the United States and the European Union to produce a low output.
D) the European Union to produce a high output and the United States to produce a low output.
25. Suppose that each of the only two firms in an industry has the independent choice of advertising its
product or not advertising. If neither advertises, each gets $20 million in profit; if both advertise, their
profits will be $10 million each; and if one advertises while the other does not, the advertiser gets $25
million profit while the other gets $4 million profit. According to game theory, the likely strategy by
the firms is:
A) both may or may not advertise.
B) one will advertise and the other will not.
C) both will advertise.
D) neither will advertise.

26. (Table: Demand for Crude Oil) The table Demand for Crude Oil shows the demand schedule for crude
oil. Assume that the crude oil industry is a duopoly and the marginal cost of producing crude oil equals
zero. If the two firms collude to share the market equally, the price of crude oil will be ________, firm
1 will produce ________ barrels, firm 2 will produce ________barrels, and each firm will earn
revenue equal to ________.
A) $80; 80; 80; $6,400
B) $80; 40; 40; $3,200
C) $60; 50; 50; $3,000
D) $40; 60; 60; $2,400
27. (Table: Demand for Crude Oil) The table Demand for Crude Oil shows the demand schedule for crude
oil. The marginal cost of producing crude oil equals zero. If the crude oil industry is a monopoly, the
price of crude oil will be ________, the total quantity of crude oil produced by the monopoly will be
________ barrels, and the monopoly will earn revenue equal to ________.
A) $80; 80; $6,400
B) $80; 80; $0
C) $160; 0; $0
D) $60; 100; $6,000
28. (Table: Demand Schedule for Gadgets) Look at the table Demand Schedule for Gadgets. The market
for gadgets is dominated by two producers, Margaret and Ray. Each firm can produce gadgets at a
marginal cost of $0. The table shows the market demand schedule for gadgets. Suppose that these
two producers have formed a cartel and are maximizing total industry profits. If Margaret decides to
cheat on the agreement and sell 100 more gadgets, Margaret's price effect will be:
A) a decrease in profit of $400.
B) an increase in profit of $400.
C) an increase in profit of $250.
D) a decrease in profit of $250.
marginal cost of $0. The table shows the market demand schedule for gadgets. Suppose that these
two producers have formed a cartel and are maximizing total industry profits. If Margaret decides to
cheat on the agreement and sell 100 more gadgets, Margaret's quantity effect will be:
A) a decrease in profit of $250.

B) an increase in profit of $150.

C) an increase in profit of $400.
D) a decrease in profit of $400.
marginal cost of $0. The table shows the market demand schedule for gadgets. If industry output is
350 gadgets produced by Margaret and 250 gadgets produced by Ray and if Ray decides to increase
output by 100, Margaret's profit will be _____ and Ray's profit will be______.
A) $1,750; $1,250
B) $1,250; $1,250
C) $1,400; $1,000
D) $1,050; $1,050
31. A strategy that is the same regardless of the action of the other player in a game is said to be a:
A) competitive strategy.
B) trigger strategy.
C) dominant strategy.
D) tit-for-tat strategy.
32. Suppose all of the firms in an industry form a cartel and succeed in raising the price to the monopoly
level by reducing output. Any single firm will find that it can increase its profits by cheating on the
cartel agreement.
A) True
B) False
33. (Table: Demand for Breakfast Cereal) The table shows the market demand schedule for breakfast cereal.
Suppose that the marginal cost of producing boxes of cereal is $0.
a) If General Mills is the sole producer of breakfast cereal, how many boxes of cereal will the firm
produce, what price will be charged, and how much revenue will be earned?
b) Now assume that Kellogg enters the market for breakfast cereal, and the breakfast cereal industry is
now a duopoly with two equal-sized firms. If these firms agree to split the monopoly output equally,
how much revenue will each firm earn under the agreement?
c) If General Mills can cheat on this agreement by producing 50 million more boxes of cereal without
punishment, will it? Analyze the price effect and quantity effect of producing 1 million more boxes to
justify your conclusion.
34. There are only two gas stations in a small town, Swifty Gas and Speedy Gas. Each firm can set either a
high price or a low price; customers view these two firms as nearly perfect substitutes. The table shows
the payoff matrix of daily profits that each firm would receive from their pricing decision, given the
pricing decision of their rival. Profits in each cell of the payoff matrix are given as (Swifty, Speedy). If
this game is played only once and each firm sets the price of gas independently, what is the Nash
equilibrium of this pricing game? Is this game an example of a prisoners' dilemma? Explain your
conclusions.
Scenario: Payoff Matrix for Firms X and Y

The following payoff matrix depicts the profits for firms X and Y, which are trying to decide whether
to choose a high or low price in their competitive strategy with each other. They are the only two firms
in this oligopolistic industry.
35. (Scenario: Payoff Matrix for Firms X and Y) In the scenario Payoff Matrix for Firms X and Y, if firms
such as firm X and firm Y wish to maximize joint profits, they should:
A) each choose their dominant strategy.
B) have one choose a dominant strategy and the other choose a nondominant strategy.
C) consider their specific situation before choosing a strategy, since strategies also entail costs.
D) each choose a nondominant strategy.
36. (Scenario: Payoff Matrix for Firms X and Y) In the scenario Payoff Matrix for Firms X and Y, if Firm Y
were to choose its dominant strategy, it would:
A) choose a low price.
B) choose a high price.
C) encounter a dilemma, since there are two dominant strategies.
D) allow firm X to dominate the industry.
37. (Scenario: Payoff Matrix for Firms X and Y) In the scenario Payoff Matrix for Firms X and Y, if firm X
were to choose its dominant strategy, it would:
A) choose a low price.
B) choose a high price.
C) encounter a dilemma, since there are two dominant strategies.
D) allow firm Y to dominate the industry.

Figure: Payoff Matrix for Ajinomoto and ADM
38. (Figure: Payoff Matrix for Ajinomoto and ADM) Given the payoff matrix in the figure Payoff Matrix
for Ajinomoto and ADM, the Nash equilibrium combination occurs when:
A) each firm produces 30 million pounds.
B) each firm produces 40 million pounds.
C) ADM produces 30 million pounds and Ajinomoto produces 40 million pounds.
D) ADM produces 40 million pounds and Ajinomoto produces 30 million pounds.
39. (Figure: Payoff Matrix for Ajinomoto and ADM) Given the payoff matrix in the figure Payoff Matrix
for Ajinomoto and ADM, the optimal combination for maximum combined profit occurs when:
A) each firm produces 30 million pounds.
B) each firm produces 40 million pounds.
C) ADM produces 30 million pounds and Ajinomoto produces 40 million pounds.
D) ADM produces 40 million pounds and Ajinomoto produces 30 million pounds.
Figure: Payoff Matrix for Jake and Zoe
40. (Figure: Payoff Matrix for Jake and Zoe) Look at the figure Payoff Matrix for Jake and Zoe. Jake and
Zoe are the only producers of slushies in their tourist town. Every week, each decides whether to price
high or price low for the following week. The figure shows the profit per week earned by their two
firms. Suppose the firms each decide to price high initially and adopt a tit-for-tat strategy for the
following weeks. After a few weeks, how much profit would each firm make per week?
A) Jake's profit = $800; Zoe's profit = $800.
B) Jake's profit = $1,000; Zoe's profit = $1,000.
C) Jake's profit = $1,500; Zoe's profit = $200.
D) Jake's profit = $200; Zoe's profit = $1,500.

41. To be called an oligopoly, an industry must have:

A) independence in decision making.
B) a horizontal demand curve.
C) a small number of interdependent firms.
D) relatively easy entry and exit.
42. Two electronic retailers, Biggest Buy and Connection City, are considering entering a small town.
Biggest Buy is the larger and more profitable of the two rivals. Each firm can either enter the market
or not. The table shows the payoff matrix of daily profits that each firm would receive from its entry
decision, given the entry decision of its rival. Profits in each cell of the payoff matrix are given as
(Biggest Buy, Connection City). Are there any dominant strategies in the game? If this game is played
only once and each firm makes the entry decision independently, what is the Nash equilibrium of this
game? Explain your conclusions.

Answer Key - 11PracticeProblemsOligopoly
1. True
2. A
3. D
4. B
5. False
6. There are no dominant strategies. If Biggest Buy enters the market, Connection City will not enter,
because earning $0 is preferred to losing $10. If Biggest Buy does not enter the market, Connection
City will enter, because earning $25 is preferred to earning $0. The same situation exists with Biggest
Buy. There are two Nash equilibriums in this game: enter/no entry and no entry/entry. In both
situations, neither firm has the incentive to deviate unilaterally from this outcome; so by definition,
these can both be defined as a Nash equilibrium.
7. B
8. D
9. A
10. C
11. B
12. C
13. A
14. B
15. B
16. B
17. A
18. B
19. True
20. B
21. C
22. B
23. A
24. C
25. C
26. B
27. A
28. D
29. C
30. D
31. C
32. True
33. a) General Mills will maximize total revenue at 250 million boxes and a price of $2.50 per box. Total
revenue is equal to $625 million.
b) If the firms split the market with a cartel agreement, total output and market price would be the
same, but total revenue for each firm would be $312.5 million.
c) If General Mills produces 50 million more boxes, the firm produces a total of 175 million boxes and
the market price will fall to $2. On the original 125 million boxes, the price effect is –$0.50 ∞ 125
million = –$62.5 million. On the additional 50 million boxes sold at $2 each, the quantity effect is +$2
∞ 50 million = +$100 million. The net change in total revenue is $37.5 million. Yes, General Mills has
an incentive to cheat on the agreement.

34. The outcome of this one-shot game is that each gas station will set a low price. Setting a low price is a
dominant strategy for each firm. If Swifty sets a high price, Speedy earns more money by setting a low
price, because earning $150 is preferred to earning $100. If Swifty sets a low price, Speedy earns more
money by setting a low price, because earning $50 is preferred to earning $25. Yes, it is an example of a
prisoners' dilemma, because in hindsight each firm can see that there is an outcome (both setting a
high price) that is mutually beneficial. Had they been able to cooperate, they might have escaped the
dilemma.
35. B
36. B
37. B
38. B
39. A
40. B
41. C
42. Biggest Buy has a dominant strategy of entering the market. No matter what Connection City chooses
to do, Biggest Buy will always prefer to enter. Connection City does not have a dominant strategy. If
Biggest Buy enters the market, Connection City will not enter because earning $0 is preferred to losing
$10. If Biggest Buy does not enter the market, Connection City will enter because earning $15 is
preferred to earning $0. The Nash equilibrium exists where Biggest Buy enters (the dominant strategy)
and Connection City does not enter. Thus, the payoffs are $25, $0.

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UNIVERSITY OF TORONTO ECO100: INTRODUCTORY ECONOMICS

DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

5. Oligopolists will earn zero profits unless they can collude.

201211 1 PRACTICE PROBLEMS: OLIGOPOLY

Figure: Payoff Matrix I for Blue Spring and Purple Rain

201211 2 PRACTICE PROBLEMS: OLIGOPOLY

12. Which of the following scenarios best describes an oligopolistic industry?

13. Airlines are prone to price wars because:

Scenario: Two Identical Firms

Figure: Payoff Matrix for Gehrig and Gabriel

201211 4 PRACTICE PROBLEMS: OLIGOPOLY

Figure: Payoff Matrix II for Blue Spring and Purple Rain

201211 5 PRACTICE PROBLEMS: OLIGOPOLY

the payoff matrix. The Nash equilibrium combination is for:

201211 6 PRACTICE PROBLEMS: OLIGOPOLY

201211 7 PRACTICE PROBLEMS: OLIGOPOLY

B) an increase in profit of $150.

Scenario: Payoff Matrix for Firms X and Y

201211 9 PRACTICE PROBLEMS: OLIGOPOLY

Figure: Payoff Matrix for Ajinomoto and ADM

Figure: Payoff Matrix for Jake and Zoe

201211 10 PRACTICE PROBLEMS: OLIGOPOLY

41. To be called an oligopoly, an industry must have:

201211 11 PRACTICE PROBLEMS: OLIGOPOLY

Answer Key - 11PracticeProblemsOligopoly

201211 12 PRACTICE PROBLEMS: OLIGOPOLY

201211 13 PRACTICE PROBLEMS: OLIGOPOLY

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