Oligopoly and Strategic Behavior

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1 Oligopoly and Strategic Behavior MULTIPLE-CHOICE QUESTIONS Like a pure monopoly, an oligopoly is characterized by: a. free entry and exit in the long run. b. free entry and exit in the short run. c. significant barriers to entry. d. all firms in the market producing the socially efficient level of output in the long run. e. a single firm selling a product with no close substitutes. ANS: C DIF: Easy TOP: I.A. REF: What Is Oligopoly? A monopolistically competitive market consists of many sellers, an oligopoly consists of seller(s), and a monopoly consists of seller(s). a. one; one b. one; two c. a few; many d. a few; one e. many; one ANS: D DIF: Medium TOP: I.B. REF: Measuring the Concentration of Industries A monopolistically competitive market consists of seller(s), an oligopoly consists of seller(s), and a monopoly consists of one seller. a. one; many b. one; two c. a few; many d. many; one e. many, a few ANS: E DIF: Medium TOP: I.B. REF: Measuring the Concentration of Industries A firm operating in an oligopolistic market has market power compared to a. a. less; firm operating in a perfectly competitive market b. the same amount of; firm operating in a perfectly competitive market c. less; monopolist d. the same amount of; monopolist e. more; monopolist

2 ANS: C DIF: Medium TOP: I.B. REF: Measuring the Concentration of Industries Economists measure oligopoly power present in an industry by using: a. capital ratios. b. concentration ratios. c. reserve ratios. d. inequality ratios. e. competition ratios. ANS: B DIF: Easy TOP: I.C. REF: Measuring the Concentration of Industries Which of the following industries is most likely an oligopoly? a. restaurant industry b. airline industry c. gold-mining industry d. wheat-growing industry e. potato-growing industry ANS: B DIF: Easy TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example Which of the following industries is most likely an oligopoly? a. wheat industry b. construction industry c. cellphone industry d. computer repair industry e. house-painting industry ANS: C DIF: Easy TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example When two or more firms set prices or quantities in unison, economists refer to them as a: a. cartel. b. monopoly. c. monopolistically competitive market. d. perfectly competitive market. e. predatory pricing unit. ANS: A DIF: Easy TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example A agreement among rival firms will most likely specify the price each firm will charge and the quantity each firm will produce/sell. a. friendly b. competitive c. monopolistic d. collusive e. price quantity

3 ANS: D DIF: Easy TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example Oligopolistic markets are because price is marginal cost. a. socially efficient; equal to b. socially efficient; less than c. socially efficient; greater than d. socially inefficient; less than e. socially inefficient; greater than ANS: E DIF: Easy TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example In the United States, prohibit collusion between rivals. a. competitive arbitration laws b. immigration laws c. anticompetition laws d. union laws e. antitrust laws ANS: E DIF: Easy TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example When two or more firms form a agreement and set price and quantity in unison, economists refer to them as. a. competitive; a cartel b. collusive; social benefactors c. collusive; a cartel d. monopolistically competitive; social benefactors e. monopolistically competitive; a cartel ANS: C DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example When a market is characterized by mutual interdependence: a. one firm s pricing decision does not affect the market share of any other firm. b. one firm s quantity decision does not affect the market share of any other firm. c. all firms always act in unison to produce the monopoly quantity. d. the actions of one firm have an impact on the price and output of its competitors. e. the actions of one firm have no impact on the price and output decisions of its competitors. ANS: D DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example If antitrust laws did not prohibit efforts to restrict competition in markets: a. no firms would attempt to collude on price and/or quantity. b. attempts at collusion with rival firms on price and or/quantity would succeed all the time. c. attempts at collusion with rival firms would probably fail more often than not. d. all firms in the economy would earn negative economic profit in the long run.

4 e. all firms in the market would earn zero economic profit in the long run. ANS: C DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example MISC: Understanding The accompanying table shows a small community s demand for monthly subscriptions to a streaming movie service. Assume that only two firms (Nextflix and Flixbuster) sell in this market, that each firm offers the same quality of service and movie selection, and that each firm s marginal cost is constant and equal to 0 (zero) due to excess capacity. Use this information to answer the next six questions. Price/Month (P) Number of Customers (Q) Total Revenue/Month (TR) $10 0 $0 $9 100 $900 $8 200 $1,600 $7 300 $2,100 $6 400 $2,400 $5 500 $2,500 $4 600 $2,400 $3 700 $2,100 $2 800 $1,600 $1 900 $900 $0 1,000 $0.If this market were highly competitive instead of a duopoly, the market price would be and the quantity of streaming movie subscriptions purchased each month would be. a. $0; 1,000 b. $2; 800 c. $4; 600 d. $6; 400 e. $8; 800 ANS: A DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying If this market were a monopoly instead of a duopoly, the market price would be and the quantity of streaming movie subscriptions purchased each month would be. a. $0; 1,000 b. $3; 700 c. $5; 500 d. $7; 300 e. $9; 100

5 ANS: C DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying If the two firms operating in this market agreed to each supply one-half of the quantity a monopolist would supply, the contract would specify that: a. Nextflix supplies 400 subscriptions and Flixbuster supplies 100 subscriptions. b. Flixbuster supplies 400 subscriptions and Nextflix supplies 100 subscriptions. c. Nextflix supplies 0 (zero) subscriptions and Flixbuster supplies 500 subscriptions. d. Flixbuster supplies 500 subscriptions and Nextflix supplies 0 (zero) subscriptions. e. Nextflix supplies 250 subscriptions and Nextflix supplies 250 subscriptions. ANS: E DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying.An agreement between Nextflix and Flixbuster to each supply 250 subscriptions is an example of: a. price discrimination. b. Bertrand competition. c. price leadership. d. collusion. e. increasing marginal costs. ANS: D DIF: Medium TOP: II.A. REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying When a third firm enters a market that was previously categorized as a duopoly, the equilibrium price: a. will be lower and the equilibrium quantity will be lower. b. will be higher and the equilibrium quantity will be lower. c. will be lower and the equilibrium quantity will be higher. d. will be higher and the equilibrium quantity will be higher. e. and the equilibrium quantity will not change. ANS: C DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms When more firms enter into a market that was previously characterized as a duopoly, it will: a. be easier for firms in the market to form a successful cartel. b. be more difficult for firms in the market to form a successful cartel. c. be just as difficult for firms in the market to form a successful cartel as it was before the new firms entered. d. be impossible for firms in the market to form a successful cartel, whereas before the new firms entered, it would have been possible. e. still be impossible for firms in the market to form a successful cartel. ANS: B DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms

6 The effect occurs when the market price either decreases or increases by the respective entrance or exit of a rival firm in the market. a. competitive b. price c. output d. market e. oligopoly ANS: B DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms Three firms are currently producing and selling in a market. When one of the three firms exits the market, economists expect that the equilibrium price: a. be lower and the equilibrium quantity will be lower. b. will be higher and the equilibrium quantity will be lower. c. will be lower and the equilibrium quantity will be higher. d. will be higher and the equilibrium quantity will be higher. e. and the equilibrium quantity will not change. ANS: B DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms MSC: Understanding Five firms are currently producing and selling in a market. When two more firms enter the market, economists expect that the equilibrium price: a. will be lower and the equilibrium quantity will be lower. b. will be higher and the equilibrium quantity will be lower. c. will be lower and the equilibrium quantity will be higher. d. will be higher and the equilibrium quantity will be higher. e. and the equilibrium quantity will not change. ANS: C DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms MSC: Understanding Six firms are currently producing and selling in a market. When two of the six firms exit the market, economists expect that the equilibrium price: a. will be lower and the equilibrium quantity will be lower. b. will be higher and the equilibrium quantity will be lower. c. will be lower and the equilibrium quantity will be higher. d. will be higher and the equilibrium quantity will be higher. e. and the equilibrium quantity will not change. ANS: B DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms MSC: Understanding.A consists of a set of players, a set of strategies available to those players, and a specification of the payoffs to each player for each possible combination of strategies. a. tournament

7 b. competitive market c. game d. firm e. monopolistically competitive market ANS: C DIF: Easy TOP: IV.A. REF: How Does Game Theory Explain Strategic Behavior? The branch of economics that studies strategic decision making is called: a. interdependence theory. b. game theory. c. competitive theory. d. noncompetitive theory. e. strategic theory. ANS: B DIF: Easy TOP: IV.A. REF: How Does Game Theory Explain Strategic Behavior? Economists use to better understand what might happen in situations where strategic interactions are involved. a. complexity theory b. strategic theory c. competitive theory d. noncompetitive theory e. game theory ANS: E DIF: Easy TOP: IV.A. REF: How Does Game Theory Explain Strategic Behavior? Economists are more likely to use game theory to analyze a(n): a. competitive market. b. monopoly. c. monopolistically competitive market. d. oligopoly. e. monopsony. ANS: D DIF: Easy TOP: IV.A. REF: How Does Game Theory Explain Strategic Behavior? When decision-makers face incentives that make it difficult to achieve mutually beneficial outcomes, we say they are in a(n): a. oligopoly dilemma. b. prisoner s dilemma. c. prison-guard s dilemma. d. monopoly dilemma. e. competitive dilemma. ANS: B DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant Strategy

8 Refer to the accompanying table. If Jane confesses, John will spend years in jail if he also confesses and years in jail if he keeps quiet. a. 10; 10 b. 10; 25 c. 10; 0 d. 0; 10 e. 25; 25 ANS: B DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant Strategy MSC: Applying Refer to the accompanying table. If Jeff confesses, Gerry will spend years in jail if he also confesses and years in jail if he keeps quiet. a. 15; 15 b. 35; 35 c. 0; 35 d. 35; 0 e. 15; 35 ANS: E DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant Strategy MSC: Applying Refer to the accompanying table. If Keisha keeps quiet, Larry will spend years in jail if he confesses and years in jail if he also keeps quiet.

9 a. 12; 1.5 b. 1.5; 12 c. 0; 12 d. 12; 12 e. 0; 1.5 ANS: E DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant Strategy MSC: Applying When a particular strategy produces a better outcome for a person regardless of the strategies others choose, we say it is a(n): a. dominated strategy. b. dominant strategy. c. equilibrated strategy. d. efficient strategy. e. surplus maximization strategy. ANS: B DIF: Easy TOP: IV.C. REF: Strategic Behavior and the Dominant Strategy MSC: Applying Refer to the accompanying table. Confessing is Eddie s dominant strategy because: a. Sharon s dominant strategy is to keep quiet. b. he spends more time in jail if he confesses, regardless of whether Sharon confesses or keeps quiet. c. he spends less time in jail if he confesses, regardless of whether Sharon confesses or keeps quiet. d. he spends the same time in jail by confessing than he would by not confessing.

10 e. his decision does not depend on Sharon s decision. ANS: C DIF: Medium TOP: IV.C. REF: Strategic Behavior and the Dominant Strategy MSC: Applying Refer to the accompanying table. In the Nash equilibrium of this game, Derrick will go to jail for years and Brandy will go to jail for years. a. 0.5; 0.5 b. 25; 25 c. 0.5; 18 d. 0.5; 25 e. 18; 18 ANS: E DIF: Medium TOP: IV.C. REF: Strategic Behavior and the Dominant Strategy MSC: Applying The Nash equilibrium in an oligopolistic market is generally for society than the outcome under collusion because the price is marginal cost. a. better; closer to b. better; further above c. worse; closer to d. worse; further above e. worse; equal to ANS: A DIF: Difficult TOP: IV.D. REF: Duopoly and the Prisoner s Dilemma MSC: Understanding Which of the following is an example of collusion? a. Nike and Reebok compete on price. b. Dell and Gateway compete on quantity. c. American Airlines and United Airlines agree to raise prices. d. Coca-Cola and Pepsi do not attempt to fix prices. e. Verizon builds more cellphone towers. ANS: C DIF: Easy TOP: IV.D. REF: Duopoly and the Prisoner s Dilemma

11 MSC: Applying The accompanying table shows two firms in a duopoly. Each firm makes its decision without knowledge of the other firm s decision. The payoffs for each firm represent economic profits, and each firm strictly prefers more economic profit than less. In this game, selling subscriptions a month is a dominant strategy for Flixbuster and selling subscriptions a month is a dominant strategy for Nextflix. a. 200; 200 b. 200; 400 c. 400; 200 d. 400; 400 e. 100; 100 ANS: D DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner s Dilemma MSC: Applying The accompanying table shows two firms in a duopoly. Each firm makes its decision without knowledge of the other firm s decision. The payoffs for each firm represent economic profits, and each firm strictly prefers more economic profit than less. If both firms were able to collude and make their supply decisions collectively, Flixbuster would sell subscriptions per month and Nextflix would sell subscriptions per month. a. 200; 200 b. 400; 400

12 c. 400; 200 d. 200; 400 e. 600; 600 ANS: A DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner s Dilemma MSC: Applying The accompanying table shows two firms in a single-stage duopoly game. Each firm makes its decision without knowledge of the other firm s decision. The payoffs for each firm represent economic profits, and each firm strictly prefers more economic profit than less. If both firms were able to write a binding contract, this contract would specify that Bobbles.com agrees to produce bobbleheads and Bobbles R Us agrees to produce bobbleheads. a. 5,000; 7,000 b. 7,000; 5,000 c. 7,000; 7,000 d. 5,000; 5,000 e. 12,000; 0 ANS: D DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner s Dilemma MSC: Applying.In January 2011, Coca-Cola and Pepsi agreed to reduce their yearly advertising budgets by $1 million each, and neither firm reneged on the agreement throughout the year. In January 2012, Coca-Cola and Pepsi each announced that their company 2011 profits had increased by $1 million. Which of the following is a likely explanation for this increase? a. A new entrant in the market caused Coca-Cola and Pepsi to lose substantial market share. b. The government imposed a punitive tax on both firms for producing a beverage that is a danger to public health. c. The firms had previously been in a prisoner s dilemma situation where one firm s advertisements were effectively canceling the other firm s advertisements. d. Coca-Cola drastically reduced the price of its soda relative to the price of Pepsi s soda. e. Pepsi drastically reduced the price of its soda relative to the price of Coca-Cola s soda. ANS: C DIF: Medium TOP: IV.E. REF: Advertising and Game Theory MSC: Understanding

13 .The accompanying table shows two firms in a single stage game. Each firm makes its decision without knowledge of the other firm s decision. The payoffs for each firm represent economic profits, and each firm strictly prefers more economic profit than less. In the Nash equilibrium of this game, Pepsi earns a profit of and Coca-Cola earns a profit of. a. $67.5 million; $67.5 million b. $30 million; $30 million c. $37.5 million; $75 million d. $75 million; $37.5 million e. $50 million; $50 million ANS: E DIF: Medium TOP: IV.E. REF: Advertising and Game Theory MSC: Applying Game theorist Robert Axelrod decided to examine the choices that participants make in a longrun setting. He ran a sophisticated computer simulation in which he invited scholars to submit strategies for securing points in a prisoner s dilemma tournament over many rounds. All the submissions were collected and paired, and the results were scored. After each simulation, he eliminated the weakest strategy and re-ran the tournament with the remaining strategies. This evolutionary approach continued until the best strategy remained. Among all strategies submitted, which strategy dominated? a. tit-for-tat strategy b. tit-for-two-tats strategy c. Axelrod equivalency strategy d. profit-maximization strategy e. grim trigger ANS: A DIF: Easy TOP: IV.F. REF: Escaping the Prisoner s Dilemma in the Long Run Player A and Player B are playing a game involving several rounds of a prisoner s dilemma where their choices are to cooperate or defect. After each round ends, one player roles a six-sided die. If the die lands on 6, the game ends; however, if the die lands on any other number, the game continues and players play another round. Prior to the game starting, the players formulate a strategy that specifies what they will do in every possible round they might find themselves in. If Player A is playing the tit-for-tat strategy, in the: a. first round, Player A will definitely choose defect. b. second round, Player A will definitely choose defect.

14 c. second round, Player A will choose whatever Player B chose in the first round. d. second round, Player A will definitely choose cooperate. e. third round, Player A will definitely choose cooperate. ANS: C DIF: Medium TOP: IV.F. REF: Escaping the Prisoner s Dilemma in the Long Run SHORT-ANSWER QUESTIONS Compare the social efficiency of oligopolistic market outcomes to perfectly competitive market outcomes and monopoly outcomes. ANS: The equilibrium price in an oligopoly is higher than the equilibrium price in a competitive market and lower than the equilibrium price in a monopoly. The equilibrium quantity in an oligopoly is lower than the equilibrium quantity in a competitive market and higher than the equilibrium price in a monopoly. Social efficiency is maximized in a perfectly competitive market where price is equal to marginal cost. Because the equilibrium price in an oligopoly is above marginal cost, the oligopoly outcome is less socially efficient than the perfectly competitive market outcome. Because the equilibrium price in an oligopolistic market is closer to marginal cost than the equilibrium price in a monopoly, the oligopoly outcome is more socially efficient than the monopoly outcome. DIF: Difficult TOP: I.B. REF: Measuring the Concentration of Industries MSC: Analyzing Explain the difference between the price effect and the output effect when a new firm enters a market. ANS: When a new firm enters a market, two effects must be considered: price and output. The price effect occurs when the market price decreases due to the entrance of a rival firm into the market. Because the price has fallen, total revenue (and total profit) for all firms falls. The output effect generates additional revenues (and additional profits) for a new entrant because the entrant increases the total quantity produced. DIF: Medium TOP: III.A. MSC: Understanding REF: Oligopoly with More Than Two Firms Airline Manufacturer A and Airline Manufacturer B are duopolists in their industry. Explain how the two firms could collectively benefit if they were to collude and form a cartel. Why might collusion be difficult? ANS: The highest combined profit can be obtained if the two firms were to collectively produce the quantity that a monopoly would produce and then charge the price that a monopoly would charge. If the firms were able to coordinate and choose their price and quantity in unison, they each could benefit by earning a share of the profit that a monopolist would earn. Collusion might be difficult to maintain because, once a collusive agreement is in

15 place, each firm has a private incentive to renege by selling a higher quantity and/or charging a lower price than its rival. DIF: Medium TOP: IV.D. Analyzing REF: Duopoly and the Prisoner s Dilemma MSC: Google and Yahoo! are two large search engine companies. Combined, these companies control a large market share in the search engine industry. Both companies currently advertise their search engines on television, and each company earns a profit of $550 million. If both companies were to stop advertising on television, each would earn a profit of $600 million. If only one company were to stop advertising on television and the other company continued to do so, the company that stopped advertising would earn a profit of $200 million and the company that continued to advertise would earn a profit of $800 million. Assume this is a simultaneous-move game where Google and Yahoo! choose to advertise or choose not to advertise, and Google and Yahoo! cannot collude. Explain the process of finding Google s dominant strategy. ANS: When Google chooses to advertise or not to advertise, Google must think about what Yahoo! will choose. If Yahoo! were to advertise, Google would earn $550 million by advertising or $200 million by not advertising. If Yahoo! were not to advertise, Google would earn $800 million by advertising or $600 million by not advertising. Regardless of what Yahoo! chooses, Google will always earn a higher profit from advertising; therefore, advertising is Google s dominant strategy in this game. DIF: Medium TOP: IV.E. Analyzing REF: Duopoly and the Prisoner s Dilemma MSC:

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