Chapter 10: Exercise Questions Essay Questions

Textbook Q.1 Q. 8 (skip Q. 5)

1. In a one-shot game, if you advertise and your rival advertises, you will each earn $5 million in profits. If neither of you advertise, your rival will make $4 million and you will make $2 million. If you advertise and your rival does not, you will make $10 million and your rival will make $3 million. If your rival advertises and you do not, you will make $1 million and your rival will make $3 million. a. Write the above game in normal form. b. Do you have a dominant strategy? c. Does your rival have a dominant strategy? d. What is the Nash equilibrium for the one-shot game? e. How much would you be willing to bribe your rival not to advertise? 2. You are considering entering a market serviced by a monopolist. You currently earn $0 economic profits, while the monopolist earns $5. If you enter the market and the monopolist engages in a price war, you will lose $5 and the monopolist will earn $1. If the monopolist doesnt engage in a price war, you will each earn profits of $2. a. Write out the extensive form of the above game. b. There are two Nash equilibria for the game. What are they? c. Is there a subgame perfect equilibrium? Explain. d. If you were the potential entrant, would you enter? Explain why or why not. 3. According to a spokesperson for cereal maker Kellogg, for the past several years, our individual company growth has come out of the other fellows hide.1 a. What implications does this statement have for the level of advertising in the cereal industry? b. Using the following hypothetical payoff matrix, explain how trigger strategies can be used to support the collusive level of advertising in an infinitely repeated game. For what values of the interest can collusion be sustained? Strategy Firm A Advertise Dont advertise Firm B Advertise 4, 4 1, 20 Dont Advertise 20, 1 10, 10

1 See F.F. Scherer, The Welfare Economics of Product Variety: An Application to the Ready-to-Eat Cereals Industry, Journal of Industrial Economics (December 1979).

4. You are the manager of the ABC novelty store, and your only competitor is the XYZ novelty store. You are both trying to decide on which magic tricks and party favors to carry in stock. The product mixes available to both of you are low, medium, and high in variety. Your expected earnings in this market are shown in the following table. Strategy Low Firm ABC Medium High Low Firm XYZ Medium 150, 200 125, 150 100, 225 High 200, 300 225, 195 150, 250

100,100 200, 75 300, 200

a. Find the Nash equilibrium (or equilibria) for a simultaneous-move, one-shot play of this game. b. What outcome would you expect in this one-shot game? Why? 5. You are the bargaining coordinator for Sun Car Manufacturers. At present you are renegotiating the labor contract with the union representative. You are bargaining over an expected 20 percent increase in earnings over the next three-year contract period. You are trying to decide whether to offer one-third, one-half, or all of the increase in earnings to the union. The union rules are such that all contracts must be voted on. The additional earnings are contingent on getting started on the new contract next week. If an agreement isnt reached on the first round of negotiations, the firm will go out of business. The union representative tells you that if you do not give the union all of the additional profits, the union members will not vote for the agreement. a. Show the extensive form of this game. b. What will you offer the union? Why?

Multiple Choice Questions

1. Consider the following information for a simultaneous move game: If you advertise and your rival advertises, you each will earn $5 million in profits. If neither of you advertise, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $15 million and the non advertising firm will earn $1 million. If you and your rival plan to be in business for only one year, the Nash equilibrium is a) For each firm to advertise. b) For neither firm to advertise. c) For your firm to advertise and the other not to advertise. d) None of the above.

2. Consider the following information for a simultaneous move game: If you advertise and your rival advertises, you each will earn $5 million in profits. If neither of you advertise, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $15 million and the non advertising firm will earn $1 million. If you and your rival plan to be in business for 10 years, then the Nash equilibrium is a) For each firm to advertise every year. b) For neither firm to advertise in early years, but to advertise in later years. c) For each firm to not advertise in any year. d) For each firm to advertise in early years, but not advertise in later years. 3. Consider the following information for a simultaneous move game: If you advertise and your rival advertises, you each will earn $5 million in profits. If neither of you advertise, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $15 million and the non advertising firm will earn $1 million. If you and your rival plan to hand your business down to your children (and this "bequest" goes on forever) then a Nash equilibrium when the interest rate is zero is a) for each firm to not advertise until the rival does, and then to advertise forever. b) for your firm to never advertise. c) for your firm to always advertise when your rival does. d) for each firm to advertise until the rival does not advertise, and then not advertise forever. 4. If you advertise and your rival advertises, you each will earn $4 million in profits. If neither of you advertise, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $1 million and the non advertising firm will earn $5 million. If you and your rival plan to be in business for only one year, the Nash equilibrium is a) For each firm to advertise. b) For neither firm to advertise. c) For your firm to advertise and the other not to advertise. d) None of the above. 5. If you advertise and your rival advertises, you each will earn $4 million in profits. If neither of you advertise, you will each earn $10 million in profits. However, if one of you advertises and the other does not, the firm that advertises will earn $1 million and the non advertising firm will earn $5 million. If you and your rival plan to be in business for 10 years, then the Nash equilibrium is a) For each firm to advertise every year. b) For neither firm to advertise in early years, but to advertise in later years. c) For each firm to not advertise in any year. d) For each firm to advertise in early years, but not advertise in later years. The following three questions are based on the following game, where firms one and two must independently decide whether to charge high or low prices.

Firm Two

High Price Firm One High Price Low Price (10, 10) (5, -5)

Low Price (5, -5) (0, 0)

6. a) b) c) d)

Which of the following are Nash equilibrium payoffs in the one-shot game? (0, 0) (5, -5) (-5, 5) (10, 10)

7. Which of the following are the Nash equilibrium payoffs (each period) if the game is repeated 10 times? a) (0, 0) b) (5, -5) c) (-5, 5) d) (10, 10) e) none of the above 8. Suppose the game is infinitely repeated. Then the "best" the firms could do in a Nash equilibrium is to earn per period. a) (0, 0) b) (5, -5) c) (-5, 5) d) (10, 10) e) none of the above 9. Consider the following entry game. Here, firm B is an existing firm in the market, and firm A is a potential entrant. Firm A must decide whether to enter the market (play "enter") or stay out of the market (play "not enter"). If firm A decides to enter the market, firm B must decide whether to engage in a price war (play "hard"), or not (play "soft"). By playing "hard", firm B ensures that firm A makes a loss of $1 million, but firm B only makes $1 million in profits. On the other hand, if firm B plays "soft", the new entrant takes half of the market, and each firm earns profits of $5 million. If firm A stays out, it earns zero while firm B earns $10 million. Which of the following are perfect equilibrium strategies? a) (enter, soft)

b) (not enter, soft) c) (enter, hard) d) (not enter, hard) The following four questions are based on the following information for a one-shot game: Firm B

Low Price Firm A Low Price High Price (2, 2) (-8, 10)

High Price (10, -8) (6, 6)

10. What are dominant strategies for Firm A and Firm B respectively? a) (low price, high price) b) (high price, low price) c) (high price, high price) d) (low price, low price) 11. What are secure strategies for firm A and firm B respectively? a) (low price, high price) b) (high price, low price) c) (high price, high price) d) (low price, low price) 12. What are the Nash equilibrium strategies for firm A and B respectively? a) (low price, high price) b) (high price, low price) c) (high price, high price) d) (low price, low price) 13. If this one-shot game is repeated 100 times, the Nash-equilibrium payoffs of the players will be ________________ each period. a) (2, 2) b) (10, -8) c) (-8, 10) d) (6, 6) 14. Which of the following is true? a) In a one-shot game, a collusive strategy always represents a Nash equilibrium.

b) A perfect equilibrium occurs when each player is doing the best he can regardless of what the other player is doing. c) Each Nash equilibrium is a perfect equilibrium. d) Every perfect equilibrium is a Nash equilibrium. e) none of the above Answer the following two questions based on the following payoff matrix: Firm B

Low Price Firm A Low Price High Price (9, 10) (7, -10)

High Price (8, 15) (11, 11)

15. Which of the following is true? a) A dominant strategy for Firm A is "high price". b) There does not exist a dominant strategy for Firm A. c) A dominant strategy for Firm B is low price. d) none of the above 16. What are the Nash equilibrium strategies for Firm A and Firm B respectively? a) (low price, low price) b) (high price, high price) c) (low price, high price) d) a. and b. 17. Which of the following is true? a) In an infinitely repeated game, collusion is always a Nash equilibrium. b) In a finitely repeated game with a certain end period, collusion is unlikely because effective punishments cannot be used during any time period. c) all of the above d) none of the above 18. Which of the following is true? a) For a finitely repeated game, the game is played enough times to effectively punish cheaters and therefore collusion is likely. b) In an infinitely repeated game with a low interest rate, collusion is unlikely because the game unravels so that effective punishment cannot be used during any time period.

c) A secure strategy is the optimal strategy for a player no matter what the opponent does. d) none of the above Refer to the following payoff matrix for the following three questions: Player 2 t1 S1 Player 1 S2 0, 0 2, 10 10, 3 4, 10 t2 3, 0 t3 1, 3

19. The dominant strategy for Player 2 is: a) t1 b) t1 and t2 c) t3 d) none of the above 20. The dominant strategy for Player 1 is: a) S1 b) S2 c) S1 and S2 d) none of the above 21. Which of the following strategies constitutes a Nash equilibrium of the game: a) S1, t1 b) S2, t2 c) S2, t3 d) S1, t2 22. Which of the following is true? a) A Nash equilibrium is always perfect. b) A perfect equilibrium is always Nash. c) A Nash equilibrium is always perfect in a multistage game. d) Perfect equilibrium and Nash equilibrium are the same concept but with different names.