Questions and Problems

Check Your Understanding

1. Question

   How do monopolistically competitive markets differ from perfectly competitive markets? If monopolistically competitive firms are making economic profits in the short run, what happens in the long run?

   Prob 10 1. How do monopolistically competitive markets differ from perfectly competitive markets? If monopolistically competitive firms are making economic profits in the short run, what happens in the long run?

2. Question

   How do monopolistically competitive firms exhibit market power? In what ways can a firm increase market power?

   Prob 10 2. How do monopolistically competitive firms exhibit market power? In what ways can a firm increase market power?

3. Question

   Explain what strategic interdependence means and how it applies to oligopoly markets.

   Prob 10 3. Explain what strategic interdependence means and how it applies to oligopoly markets.

4. Question

   Why is it difficult for cartels to maintain high prices effectively over the longer term?

   Prob 10 4. Why is it difficult for cartels to maintain high prices effectively over the longer term?

5. Question

   Why would the use of repeated games make overcoming the Prisoner’s Dilemma easier compared to a game that is played only once?

   Prob 10 5. Why would the use of repeated games make overcoming the Prisoner’s Dilemma easier compared to a game that is played only once?

6. Question

   What is the difference between a tit-for-tat trigger strategy and a grim trigger strategy?

   Prob 10 6. What is the difference between a tit-for-tat trigger strategy and a grim trigger strategy?

Apply the Concepts

7. Question

   “Monopolistic competition has a little of monopoly and a little of competition, hence its name.” Do you agree? Why or why not?

   Prob 10 7. “Monopolistic competition has a little of monopoly and a little of competition, hence its name.” Do you agree? Why or why not?

8. Question

   We saw in the last chapter that the HHI (Herfindahl-Hirschman index) is used by the Department of Justice to measure industry concentration. Because domestically we have very few monopolies, some would argue that the HHI is really used to measure the degree of oligopoly. However, the HHI represents domestic concentration, and many of the products we purchase are made globally and sold in the United States by foreign firms. Has global competition made these HHI estimates less meaningful? Are old-line American oligopolies (autos, steel, and airlines) more like monopolistic competitors today? Why or why not?

   Prob 10 8. We saw in the last chapter that the HHI (Herfindahl-Hirschman index) is used by the Department of Justice to measure industry concentration. Because domestically we have very few monopolies, some would argue that the HHI is really used to measure the degree of oligopoly. However, the HHI represents domestic concentration, and many of the products we purchase are made globally and sold in the United States by foreign firms. Has global competition made these HHI estimates less meaningful? Are old-line American oligopolies (autos, steel, and airlines) more like monopolistic competitors today? Why or why not?

9. Question

   In both competitive and monopolistically competitive markets, firms earn normal profits in the long run. What enables oligopoly firms to have the opportunity to earn economic profits in the long run?

   Prob 10 9. In both competitive and monopolistically competitive markets, firms earn normal profits in the long run. What enables oligopoly firms to have the opportunity to earn economic profits in the long run?

10. Question

    Poker players are known to bluff once in a while, meaning that they will make a large bet despite holding bad cards in an effort to pressure other players to fold their hands. Would bluffing be considered a dominant strategy to be used in poker?

    Prob 10 10. Poker players are known to bluff once in a while, meaning that they will make a large bet despite holding bad cards in an effort to pressure other players to fold their hands. Would bluffing be considered a dominant strategy to be used in poker?

11. Question

    Suppose you choose to pledge for your top choice of sorority or fraternity at your university. Despite the tiny odds of getting accepted into your top choice, that does not deter you from spending all of rush week focusing on your top choice. Would this strategy coincide with a best-response strategy in a Nash equilibrium?

    Prob 10 11. Suppose you choose to pledge for your top choice of sorority or fraternity at your university. Despite the tiny odds of getting accepted into your top choice, that does not deter you from spending all of rush week focusing on your top choice. Would this strategy coincide with a best-response strategy in a Nash equilibrium?

12. Question

    Suppose two competing stores each announce a “low price guarantee,” meaning that each store would match the prices of the other store if they were lower. Does providing this guarantee make it easier or more difficult to overcome the Prisoner’s Dilemma facing the two firms?

    Prob 10 12. Suppose two competing stores each announce a “low price guarantee,” meaning that each store would match the prices of the other store if they were lower. Does providing this guarantee make it easier or more difficult to overcome the Prisoner’s Dilemma facing the two firms?

In the News

13. Question

    The Wall Street Journal reported on April 25, 2012, that Pakistan launched a test missile in response to India launching a missile of its own the previous week. Both countries want to prove that they are the dominant military power in South Asia. Explain how this ongoing game between nuclear powers represents a game of chicken, and what might happen if neither side chooses to back down.

    Prob 10 13. The Wall Street Journal reported on April 25, 2012, that Pakistan launched a test missile in response to India launching a missile of its own the previous week. Both countries want to prove that they are the dominant military power in South Asia. Explain how this ongoing game between nuclear powers represents a game of chicken, and what might happen if neither side chooses to back down.

14. Question

    “Bank of America Faces Outrage over Debit Card Charge” was the headline in the Washington Post on September 30, 2011. Bank of America attempted to institute a new fee on debit card accounts by charging its debit card users $5 per month, in hopes that other banks would follow its lead. However, no other major bank did, and Bank of America was pummeled in the media and by customers who closed their accounts until Bank of America relented and dropped the new fee. Explain how Bank of America was attempting to overcome the Prisoner’s Dilemma. Provide reasons why this attempt was unsuccessful.

    Prob 10 14. “Bank of America Faces Outrage over Debit Card Charge” was the headline in the Washington Post on September 30, 2011. Bank of America attempted to institute a new fee on debit card accounts by charging its debit card users $5 per month, in hopes that other banks would follow its lead. However, no other major bank did, and Bank of America was pummeled in the media and by customers who closed their accounts until Bank of America relented and dropped the new fee. Explain how Bank of America was attempting to overcome the Prisoner’s Dilemma. Provide reasons why this attempt was unsuccessful.

Solving Problems

15. Question

    Suppose each member of a diamond cartel consisting of five producers agrees to sell 100 carats of diamonds a day. With 500 total carats being sold, the market price is $1,000/carat, and each firm earns $100,000. Now assume that one producer cheats by producing 110 carats, causing the market price for 510 total carats to drop to $980/carat. How does this action affect the revenues of the cheating firm and the noncheating firms? Suppose the four noncheating firms change course and all produce 110 carats, and the market price for 550 total carats drops to $850/carat. How much does each firm earn now? How important is loyalty to maintaining an effective cartel?

    Prob 10 15. Suppose each member of a diamond cartel consisting of five producers agrees to sell 100 carats of diamonds a day. With 500 total carats being sold, the market price is $1,000/carat, and each firm earns $100,000. Now assume that one producer cheats by producing 110 carats, causing the market price for 510 total carats to drop to $980/carat. How does this action affect the revenues of the cheating firm and the noncheating firms? Suppose the four noncheating firms change course and all produce 110 carats, and the market price for 550 total carats drops to $850/carat. How much does each firm earn now? How important is loyalty to maintaining an effective cartel?

16. Question

    The following shows a pricing game between JetBlue and Delta. Each airline has a choice between engaging in a fare sale or not. The resulting profits of each airline are provided, where the first number in each payoff box equals JetBlue’s profit and the second number is Delta’s profit.

    
    
    
    

    
    
    What is the Nash equilibrium of this game? Does this game resemble a Prisoner’s Dilemma? Explain.

    Prob 10 16. The following shows a pricing game between JetBlue and Delta. Each airline has a choice between engaging in a fare sale or not. The resulting profits of each airline are provided, where the first number in each payoff box equals JetBlue’s profit and the second number is Delta’s profit.
    What is the Nash equilibrium of this game? Does this game resemble a Prisoner’s Dilemma? Explain.

17. Question

    According to By the Numbers, in terms of number of restaurants, what percentage of all restaurants among the top ten chains is a Subway, McDonald’s, or a Starbucks? (Hint: First calculate the total number of Subways, McDonald’s, and Starbucks combined and compare with the total restaurants among all top ten chains.)

    Prob 10 17. According to By the Numbers, in terms of number of restaurants, what percentage of all restaurants among the top ten chains is a Subway, McDonald’s, or a Starbucks? (Hint: First calculate the total number of Subways, McDonald’s, and Starbucks combined and compare with the total restaurants among all top ten chains.)

18. Question

    According to By the Numbers, if the third and fourth largest wireless providers merged into one new company, would the combined company surpass the market share of either of the largest two firms prior to the merge?

    Prob 10 18. According to By the Numbers, if the third and fourth largest wireless providers merged into one new company, would the combined company surpass the market share of either of the largest two firms prior to the merge?