AP Microeconomics

6.3 AP Free Response Assignment

The following is a free response question released by the College Board from a previous AP exam to be
used as practice for future exams. You can complete the assignment in this document, using the drawing
tools in Word (or any photo editing program) or print this document, and complete the activity by hand,
submitting a scan or photo of your work. When you are done, submit the assignment for grading by your
instructor. This question will be graded out of 6 points.

1. Two interdependent bus companies—City Wheels and Easy Ride—provide transportation services in
the same city. Following a change in costs that affects both companies, each company must decide
whether to lower its fare or maintain its current fare. In the payoff matrix below, the first entry in each
cell indicates the daily profit to Easy Ride and the second entry indicates the daily profit to City Wheels.
Both companies know all of the information in the matrix.

(a) If Easy Ride chooses to maintain its current fare, which strategy is better for City Wheels?
Explain.
If Easy Ride chooses to maintain its current fare, then the better strategy for City Wheels is to
maintain its own fare. This is because of the two options City Wheels has: maintain fare or lower
fare, it can either earn $180 if it maintains the fare or $120 if it lowers the fare. And because
$180>$120, it should choose to maintain the fare.

(b) Is there a dominant strategy for Easy Ride? Explain.

Easy Ride does not have a dominant strategy – this is because the best strategy that Easy Ride
has depends on the decision that City Wheels makes ($150>$120, but $130<$140).

(c) Assume that the companies must make their decisions simultaneously and do not cooperate.
What will be the daily profit for each firm?
If they make their decisions simultaneously, they will both choose to maintain their fare. Thus
the profit of Easy Ride is $150 and the profit of City Wheels is $180.

(d) If these two firms could cooperate, which strategy would each firm choose?

The firms would both choose to maintain their current prices, as they would earn the most
money that way.

(e) Suppose that the local government decides to provide a subsidy of $40 per day to the bus
companies. However, only a company that agrees to lower its fare is eligible to receive the
subsidy. Draw a new payoff matrix to reflect the change in government policy.
Maintain Lower
Maintain $150, $180 $130, $160
Lower $160, $130 $180, $150