Microeconomics (2nd Edition) (Pearson Series in Economics)
2nd Edition
ISBN: 9780134492049
Author: Daron Acemoglu, David Laibson, John List
Publisher: PEARSON
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Chapter 14, Problem 1P
(a)
To determine
The game tree
To determine
The optimal solution of game through backward induction
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Consider the following entry-deterrence game. A potential entrant has two strategies, “Enter” or “Stay Out”. An incumbent firm can either Price Low or Price High, depending on whether they want to try to fight or accommodate the entrant. (The Price Low option could be a limit price, for example). Suppose if the entrant Enters and the incumbent Prices Low, both firms lose $-1M. If the entrant enters and the incumbent Prices High, each firm earns $2M. If the Entrant doesn’t enter, the incumbent earns $4M and the entrant earns $0.
a)Using the concept of Nash Equilibrium, what are the predicted strategies and profits? Set up a game box or tree and explain your reasoning.
b) Give an example of a different profit outcome that would lead to a different Nash Equilibrium. (From this, you can see that sometimes deterrence is effective and sometimes it isn’t, depending on the profits).
Refer to the normal-form game of price competition in the payoff matrix below
Firm B
Low Price
High Price
Firm A
Low Price
0, 0
50, −10
High Price
−10, 50
20, 20
Suppose the game is infinitely repeated, and the interest rate is 20 percent. Both firms agree to charge a high price, provided no player has charged a low price in the past. This collusive outcome will be implemented with a trigger strategy that states that if any firm cheats, then the agreement is no longer valid, and each firm may make independent decisions. Will the trigger strategy be effective in implementing the collusive agreement? Please explain and show all necessary calculations.
Alcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose prices of their 500 foot rolls of sheet aluminum on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make.
Suppose Alcoa and Kaiser repeat their pricing decision on the first day of every month. Suppose they have been cooperating for the past few months, but now the manager at Kaiser is trying to decide whether to cheat or to continue cooperating. Kaiser’s manager believes Kaiser can get away with cheating for two months, but he also believes that Kaiser would be punished for the next two months after cheating. After punishment, Kaiser’s manager expects the two firms would return to cooperation. Kaiser’s manager ignores the time-value of money and does not discount future benefits or costs.
Will Kaiser cooperate or cheat? Explain.
Chapter 14 Solutions
Microeconomics (2nd Edition) (Pearson Series in Economics)
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- Alcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose prices of their 500 foot rolls of sheet aluminum on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make. Suppose Alcoa and Kaiser repeat their pricing decision on the first day of every month. Suppose they have been cooperating for the past few months, but now the manager at Kaiser is trying to decide whether to cheat or to continue cooperating. Kaiser’s manager believes Kaiser can get away with cheating for two months, but he also believes that Kaiser would be punished for the next two months after cheating. After punishment, Kaiser’s manager expects the two firms would return to cooperation. Kaiser’s manager ignores the time-value of money and does not discount future benefits or costs. 4. Suppose you were asked to manage a golf course that was currently charging a uniform price. Would you suggest that the course continue…arrow_forwardAlcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose prices of their 500 foot rolls of sheet aluminum on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make. Suppose Alcoa and Kaiser repeat their pricing decision on the first day of every month. Suppose they have been cooperating for the past few months, but now the manager at Kaiser is trying to decide whether to cheat or to continue cooperating. Kaiser’s manager believes Kaiser can get away with cheating for two months, but he also believes that Kaiser would be punished for the next two months after cheating. After punishment, Kaiser’s manager expects the two firms would return to cooperation. Kaiser’s manager ignores the time-value of money and does not discount future benefits or costs. What is the monthly gain to Kaiser from cheating? What is the present value of the benefit from cheating for the two months of cheating?arrow_forwardAlcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose prices of their 500 foot rolls of sheet aluminum on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make. Suppose Alcoa and Kaiser repeat their pricing decision on the first day of every month. Suppose they have been cooperating for the past few months, but now the manager at Kaiser is trying to decide whether to cheat or to continue cooperating. Kaiser’s manager believes Kaiser can get away with cheating for two months, but he also believes that Kaiser would be punished for the next two months after cheating. After punishment, Kaiser’s manager expects the two firms would return to cooperation. What is the monthly cost of punishment to Kaiser? What is the present value of the cost of cheating for the two months of punishment?arrow_forward
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- Suppose there are only two firms that sell smartphones, Flashfone and Pictech. The payoff matrix that follows shows the profit (in millions of dollars) each company will earn, depending on whether it sets a high or low price for its phones. For example, the lower-left cell shows that if Flashfone prices low and Pictech prices high, Flashfone will earn a profit of $6 million and Pictech will earn a profit of $1 million. Assume this is a simultaneous game and that Flashfone and Pictech are both profit-maximizing firms.arrow_forwardPfizer and a competitor, Astra-Zeneca, are considering developing a new drug for a particular illness at the same time. The illness is relatively rare but the fixed cost of production is very high. In particular, the forecast demand for such a drug is insufficient to cover both firms’ costs. Analyse the interaction between the two firms using game theory. Present a payoff matrix to model the situation and analyse it for Nash equilibrium. What can either of these firms do to make their best, most- preferred outcome more likely?arrow_forwardThe only two firms in a market are trying to decide what price to charge. The payoff matrix for this duopoly game is shown below. The payoffs are thousands of dollars of economic profit. In the Nash equilibrium, A). Firm A and Firm B are both making $80,000 in economic profit. B). Firm A and Firm B are both making $75,000 in economic profit. C). Firm A is making $80,000 and Firm B is making $75,000 in economic profit. D). Firm A and Firm B are both making $60,000 in economic profit.arrow_forward
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