Homework 2 Problem 1 a) What are the characteristics of a perfectly competitive industry? b) Why do economists use game theory to study the actions of firms in oligopoly markets but not in other markets we have studied? c) Suppose that two cereal producers are playing a “price war” game. They can either charge a high or low price. The matrix below shows the possible profits in case of particular strategy. Does any firm have a dominant strategy in this game? Find the Nash equilibrium of the game and argue whether it represents the best possible outcome according to the matrix. ​ ​ Kellogg's ​ ​ Price High Price Low General Mills Price High GM: $50 mil K: $60 mil GM: $10 mil K: $110 mil Price Low GM: $100 mil K: $20 mil GM: $25 mil K: $30 mil Problem 2 The following table shows the total output produced by the top six firms as well as the total industry output for each industry. Firm Industry J Industry K Industry L Industry M 1 14,288 7,878 1,554 22,987 2 12,128 7,242 1,486 21,444 3 11,192 5,321 1,294 18,787 4 3,245 4,900 1,287 16,454 5 2,442 4,526 911 12,890 6 1,004 3,800 745 10,045 Total 55,050 70,250 7,340 198,400 i) What is the concentration ratio for Industry J? ii) Which industry is the least competitive? iii) Which industry has the lowest concentration ratio? Problem 3 The figure is drawn for a monopolistically competitive firm Chart, line chart Description automatically generated i) What is the firm’s profit maximizing level of output? ii) In order to maximize profit, what price the firm will charge? iii) Suppose that average total cost is $36 when Q=24. What is the profit-maximizing price and resulting profit? iv) If the average variable cost is $24 at the profit maximizing quantity, and if the firm’s fixed costs amount to $60, then what is the firm’s maximum profit? v) If the average variable cost is $26 at the profit maximizing quantity, and if the firm’s profit is $40 at that quantity, then what its fixed costs amount to? vi) Suppose you were to add the ATC curve to the diagram to show the firm in a situation of long-run equilibrium. You would draw the ATC curve a. with its minimum at the point (Q = 24, P = $36). b. with its minimum at the point (Q = 24, P = $24). c. tangent to the demand curve at the point (Q = 24, P = $36). d. tangent to the demand curve at the point (Q = 32, P = $32). vii) If the ATC=40 at the profit-maximizing level of output, which of the following will occur in the long run in this industry? a. Firms will exit this industry. b. Firms will enter this industry. c. This firm will continue to earn positive economic profits. d. This firm will incur losses. Problem 4 For a monopolist, when the price effect is greater than the output effect, marginal revenue is a. positive. b. negative. c. zero. d. maximized. Problem 5 A profit-maximizing monopolist charges a price of $12. The intersection of the marginal revenue and marginal cost curves occurs where output is 10 units and marginal cost is $6. Average total cost for 10 units of output is $5. What is the monopolist’s profit? a. $60 b. $70 c. $100 d. $120 The main problem from last year FINAL EXAM Imagine that in Brno two residents, Lucia and Silvia own wells that produce safe drinking water. Each week Lucia and Silvia work together to decide how many gallons of water to pump. They bring the water to town and sell it at whatever price the market will bear. To keep things simple, suppose that Lucia and Silvia can pump as much water as they want without cost so that the marginal cost of water equals zero. The weekly town demand schedule and total revenue schedule for water is shown in the table below: Weekly Quantity (in gallons) Price Weekly Total Revenue (and Total Profit) Marginal Revenue 0 $12 $ 0 25 11 275 50 10 500 75 9 675 100 8 800 125 7 875 150 6 900 175 5 875 200 4 800 225 3 675 250 2 500 275 1 275 300 0 0 a) Calculate marginal revenue for this demand schedule. b) If Lucia and Silvia operate as a profit-maximizing monopoly in the market for water, what price will they charge and how many gallons of water will they produce? c) If Lucia and Silvia operate as a profit-maximizing monopoly in the market for water, how much profit will each of them earn? d) If the market for water were perfectly competitive instead of monopolistic, how many gallons of water would be produced and sold? e) Draw a graph showing market demand curve, marginal revenue and marginal cost curves, monopolistic profit and the dead weight loss. You do not have to be precise. f) Calculate the dead weight loss of the monopolistic allocation in which Lucia and Silvia form a cartel. g) Draw the payoff matrix of this game considering that the monopolistic allocation may not be a Nash equilibrium. h) What does having a dominant strategy mean in a strategic situation? Do Lucia and Silvia have one? i) What will be the price and the market quantity of water once Lucia and Silvia reach a Nash equilibrium? j) Under what circumstances is it possible to achieve more favorable cartel allocation?