2. Suppose two Cournot duopolist rms operate at zero marginal cost. The market demand is p = a bq. Firm 1 s best-response function is

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1 Econ301 (summer 2007) Quiz 1 Date: Jul 5 07 Instructor: Helen Yang PART I: Multiple Choice (5 points each, 75 points in total) 1. In the long run, a monopolistically competitive rm (a) operates at full capacity. (b) produces at minimum average cost. (c) earns zero economic pro t. (d) All of the above. 2. Suppose two Cournot duopolist rms operate at zero marginal cost. The market demand is p = a bq. Firm 1 s best-response function is (a) q 1 = a=2b. (b) q 1 = (a (c) q 1 = a=b. (d) q 1 = (a 2bq 2 )=2b. bq 2 )=2b. 3. An incumbent s threat to retaliate after a potential competitor enters the market will be taken seriously by potential competitors if (a) the potential entrant cannot earn a pro t if the threat is carried out. (b) the incumbent earns greater pro t carrying out the threat than by accommodating entry. (c) the potential entrant s pro t exceeds the incumbent s if the threat is carried out. (d) the incumbent can still earn a pro t after carrying out the threat. 4. In a two-player simultaneous game where neither player has a dominant strategy, (a) the actual outcome can be unpredictable. (b) there is only one Nash equilibrium. (c) there is never a Nash equilibrium. (d) the actual outcome will not be a Nash equilibrium. 5. A risk-preferring person is willing to pay (a) to obtain decreasing marginal utility. (b) a fee to make a fair bet. (c) a certainty equivalent. (d) None of the above. 1

2 Use the gure below to anser question 6 and The above gure shows Bob s utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob s expected wealth is (a) $0 (b) $50 (c) $100 (d) $75 7. To reduce the chance of theft to zero, Bob is willing to pay (a) $20. (b) $80. (c) $70. (d) $ Which of the following games involving the roll of a single die is a fair bet? (a) Bet $1 and receive 1$ if 3, 4, or 5 comes up. (b) Bet $1 and receive 1$ if 3 or 4 comes up. (c) Bet $1 and receive 4$ if 6 comes up. (d) None of the bets is a fair bet. 2

3 9. Suppose twenty neighbors share a park. One of the neighbors, Al, leaves trash in the park. This bothers the other neighbors. According to Coase s theorem, assigning the property rights to the park to Al (a) will achieve the socially optimal quantity of trash. (b) will result in zero trash being dumped in the park. (c) is unfair. (d) might still not achieve the social optimum since coordinating the other nineteen neighbors can be costly. 10. If a production process generates pollution, then a competitive market will (a) produce the socially optimal quantity of that good. (b) produce zero output. (c) produce less of the good than is socially optimal. (d) produce more of the good than is socially optimal. 11. In the presence of an negative externality, a speci c tax can achieve the social optimum because (a) it internalizes the external cost. (b) output is reduced to zero as a result. (c) the price of the good rises by the full amount of the tax. (d) it eliminates pollution once and for all. 12. The gure below shows a payo matrix for two rms, A and B, that must choose between selling basic computers or advanced computers. How many Nash equilibria are there? (The upper-right corner shows payo to B, and lower-left corner shows that to A.) (a) 4 (b) 1 (c) 0 (d) 2 3

4 13. The gure below shows the payo to two airlines, A and B, of serving a particular route. If the two airlines must decide simultaneously, which one of the following statements is true? (The upper-right corner shows payo to B, and lower-left corner shows that to A.) (a) Firm A has a dominant strategy. (b) The outcome of the game is unpredictable. (c) Neither rm entering is a Nash equilibrium. (d) Firm B has a dominant strategy. 14. The gure below shows the reaction functions for two pizza shops in a small isolated town. Collusion could result in (a) each rm producing 25 pizzas. (b) each rm producing 50 pizzas. (c) each rm producing 40 pizzas. (d) rm A monopolizing the market by selling 50 pizzas. 4

5 15. The gure below shows the market for steel ingots. If the market is competitive, then the deadweight loss to society is (a) a (b) b (c) c (d) zero PART II: Short Answer (25 points in total) 1. For Pepsi, pro t maximization means max = q p p p m q p F; where F = xed cost for Pepsi. F p = 50 + p c + 2m 4p p = 0 =) p p = 12:5 + m 2 + p c 4 =) A $1 increase in marginal cost yields a $0.50 increase in price. A $1 increase in Coke s price yields a $0.25 increase in Pepsi s price. 2. Let U i be person i s utility, where i = A(Alvin); B(Barry); C(Carl): Initial utility: U A = 100; U B = = 10; 000; U C = 100 0:5 = 10 Carl s expected utility is E(U C ) = (0:1 1; 000 0:5 ) + (0:9 0 0:5 ) = 3:16. This is less than his current utility of 10. He will not make the investment. (Carl is risk averse.) Alvin s expected utility is E(U A ) = (0:1 1; 000) + (0:9 0) = 100. This equals his current utility of 100. So Alvin is indi erent whether making this investment or not. Alvin is risk neutral. Barry s expected utility is E(U B ) = (0:1 1; 0002) + (0:9 02) = 100; 000. This exceeds his current utility of 10,000. Barry is risk loving and will make the investment. 5

6 3. First, the socially optimal quantity of paper is found by setting MC P +MC e = p; or 10+Q+Q = 100 Q. Rearranging yields Q = 30. The competitive equilibrium is found by setting MC P = p; or 10+Q = 100 Q. Rearranging yields Q = 45. The deadweight loss of those additional units equals (45 30) 45=2 = 337:50. Under monopoly, the rm sets MC P = 100 2Q or Q = 30. The monopoly produces the socially optimal quantity, and therefore has no deadweight loss. Social welfare is greater under monopoly. 6

Price competition with homogenous products: The Bertrand duopoly model [Simultaneous move price setting duopoly]

ECON9 (Spring 0) & 350 (Tutorial ) Chapter Monopolistic Competition and Oligopoly (Part ) Price competition with homogenous products: The Bertrand duopoly model [Simultaneous move price setting duopoly]