Econ 110

Spring 2019 Name: _______________________

Section_______________________
Koker and Simons

Problem Set 7 (5 points)

Each question is worth 1 point (unless otherwise specified), with sub parts equally weighted, unless
indicated otherwise.

1. (0.5 point) Why is there so much advertising in monopolistic competition and oligopoly? How does
such advertising help consumers and promote efficiency? Why might it be excessive at times?

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2. (0.5 point) Consider a two-firm industry that produces a homogeneous widget. The firms in the
industry, Widgetech and Widgetmania, have two salient strategy alternatives: each can charge either $10
or $12 per widget. A market study, available to the two firms, has revealed the following:

--If both firms charge $10, each will earn $5,000.

--If both firms charge $12, each will earn $10,000.
--If Widgetech charges $10, while Widgetmania charges $12, the former will earn $12,000 and the latter
$4,000.
--If Widgetech charges $12, while Widgetmania charges $10, the former will earn $4,000 and the latter
$12,000.

a) Write down the strategies available to the two firms and the corresponding payoffs (in terms of
profits) in game matrix form.

b) Find the equilibrium set of prices.

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3. (0.5 point) 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
payoff matrix below.

Firm 1

Big Car Small Car

Π1 = 300 Π 1 = 700
Big Car Π 2 = 300 Π 2 = 900

Firm 2 Π1 = 900 Π 1 = 500

Π 2 = 700 Π 2 = 500
Small Car

a) Does either firm have a dominant strategy? Why?

b) There are two Nash Equilibria for this game. Identify them.

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4. (0.5 point) The following payoff matrix represents the long-run payoffs for two duopolists faced with
the option of buying or leasing buildings to use for production. Determine whether any dominant
strategies exist and whether or not there is a Nash equilibrium.

Firm 1

Lease Buy

Building Building

Lease F1 = 500 F1 = 750

Firm 2 F2 = 500 F2 = 400

Buy F1 = 300 F1 = 600

F2 = 600 F2 = 200

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5. (2 points) Because of their unique expertise in making sport shoes the D Brothers have long enjoyed a
monopoly in the European market. The annual demand for D Shoes is 90 – Q, where Q is in millions.
The marginal cost of their shoe is 30.

a. How many D shoes are sold annually and at what price? What is the annual profit (if any) of the D
Brothers?

b. A family dispute broke the firm in two. Alfredo D now runs one firm and Ludwig D runs the other.
They still have the same marginal costs but now they are Cournot duopolists. How many shoes are sold
by each firm? What is the price? What is the annual profit (if any) of each firm?

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c. Assume now that they are Stackelberg duopolists with Alfredo D acting as the leader. How many
shoes are sold by each firm? What is the price? What is the annual profit (if any) of each firm?

d. Assume now that they are Bertrand duopolists. How many shoes are sold by each firm? What is the
price? What is the annual profit (if any) of each firm?

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6. Two firms compete in selling identical widgets. They choose their output levels Q1 and Q2
simultaneously and face the demand curve P = 30 – Q where Q = Q1 + Q2. Until recently, both firms had
zero marginal costs. Recent environmental regulations have increased Firm 2’s marginal cost to $15. Firm
1’s marginal cost remains constant at zero.

True or false: As a result, the market price will rise to the monopoly level.