Review Questions VIII (ECON501.

01)
Taehyun Ahn
1. A dominant strategy would mean that one of the players
A) follows the moves of the opponent no matter what the opponent does.
B) knows the payoff matrix outcomes while the other does not.
C) is sure to come out with the most preferred outcome no matter what the other does.
D) will benefit most from one particular move no matter what the opponent does.

2. Firm 1 and firm 2 are automobile producers. Each has the option of producing either a big
car or a small car. The payoffs to each of the four possible combinations of choices are as
given in the following payoff matrix. Each firm must make its choice without knowing what
the other has chosen. What is (are) the Nash equilibrium(a)?

# The numbers are profit of firm (2, 1).

Firm 1
Big Car Small Car
Firm 2 Big Car (400, 400) (1000, 800)
Small Car (800, 1000) ( 500, 500)

3. Suppose we have the same payoff matrix as in problem 2 except now firm 1 gets to move
first and knows that firm 2 will see the results of this choice before deciding which type of
car to build. Draw the game tree for this sequential game. What is the Subgame perfect Nash
equilibrium for this game?

4. In the Cournot model

A) each firm takes the quantities produced by its rivals as given.
B) each firm takes the prices charged by its rivals as given.
C) one firm plays a leadership role and its rivals merely follow.
D) prices are higher and quantities are slightly less than we would see if the firms
colluded.

5. Which of the duopoly models has the highest overall combined profit level?
A) the Cournot model
B) the Bertrand model
C) the Stackelberg Leader-Follower model
D) the shared monopoly model

Use the following to answer questions 6-12:

The following questions relate to an oligopoly market where the industry demand curve is P =
100 - Q.

6. Derive the reaction curve for a Cournot duopolist where the industry demand curve is as
stated above and the MC of production is zero.

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Review Questions VIII (ECON501.01)
Taehyun Ahn
7. What will industry output be at equilibrium in this model?

8. If the Bertrand model is assumed to be the appropriate one for analysis, what will the
price of the product and the quantity sold be in this duopoly market?

9. What will be the price and quantity of this duopoly market if the duopolists act as shared
monopolists?

10. If firm 1 is a Stackelberg leader and firm 2 is a follower, what will each firm produce?

11. What price will the two Stackelberg firms charge?

12. Compare the models analyzed here with reference to the consumer and economic
efficiency.

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Review Questions VIII (ECON501.01)
Taehyun Ahn
Answer
1. D

2. One firm producing a big car and the other producing a small car. (two Nash equilibria)

3.
D 400 for Firm 1
Big car 400 for Firm 2

Big car B
Firm 2
Small car E 1000 for Firm 1
800 for Firm 2
A
Firm 1
Big car F 800 for Firm 1
1000 for Firm 2

Small car C
Firm 2
Small car G 500 for Firm 1
500 for Firm 2

If firm 1 chooses the big car, firm 2 will choose the small car (point E). If firm 1 chooses the small car,
firm 2 will choose the big car (point F). Since profits for firm 1 are higher at E than at F, firm 1 will
choose big car to begin with. So the subgame perfect Nash equilibrium for this game occurs at point E.

4. A

5. D

6.
P = (100 - Q2) - Q1
MR = 100 - Q2 - 2Q1
MC = MR
0 = 100 - Q2 - 2Q1
2Q1 = 100 - Q2
Q1 = 50 - .5Q2 = firm 1's reaction curve

7.
Since firm 2's reaction will be Q2 = 50 - .5Q1 we can solve reaction curve 2 for Q1 and set the
two reaction curves equal to each other to find the equilibrium output which is 33 and 1/3 (=
100/3) for each firm. Thus, industry output is 200/3.

8.
Since both firms will undercut each other's price until they reach marginal cost, the price will end

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Review Questions VIII (ECON501.01)
Taehyun Ahn
up at zero and the industry output will be 100, which is all that can be given away at zero price.

9.
The MR = MC solution will be where MR = 0, which is where 100 - 2Q = 0. Q will equal 50,
and both firms will produce and sell 25. They can price at 50 and each sell 25.

10.
P = 100 - (Q1 + 50 -.5Q1)
P = 100 -.5Q1 -50
P = 50 - .5Q1
MR = 50 - Q1
0 = 50 - Q1
Q1 = 50
Q2 = 50 - .5(50) = 25

11.
Firm 1 will price at 25 [25 = 50 - .5(50)].
Firm 2 will price at 25, since it follows the leader.

12.
The Bertrand model produces the most at the lowest price. Price is equal to marginal cost so the
output is socially efficient. The shared monopoly is the least desirable because it charges the
most and produces the least and price is above marginal cost by the greatest amount. The
Stackelberg outperforms the Cournot model for second place on the list. It has the second highest
output and the second lowest price. The Cournot model is in third place based on the price and
quantity efficiency criteria.