< Midterm Exam:
Answer Key
>
(ECON 2: Spring 2008)
(
Market Imperfection and Policies; Prof. YoungHan Kim
)
1. Assume that there are only two automobile producers in the US, GM and Ford. They have two pricing
strategies: High pricing and Low pricing strategy, and they decide simultaneously. If both of them
successfully collude to set high pricing strategies, each of them gets 200 dollars. However, if GM betrays to
choose Low pricing strategy while Ford sets the promised High pricing strategy, GM gets 300 dollars while
Ford gets 100 dollars, and vice versa. (i.e., if Ford betrays to Low pricing strategy and GM keeps High
pricing strategy, Ford gets 300 dollars and GM gets 100 dollar.) If both of them betray to choose Low
pricing strategies, each gets 0 Dollars.
i) When both firms make their decision on the model simultaneously in a one shot game, determine the Nash
Equilibrium after drawing a payoff matrix. (5 points)
GM
High Pricing
Low Pricing
High Pricing
(200, 200)
(100,
300^
)
Ford
Low Pricing
(
300
, 100)
(
0
, 0^
)
O Nash equilibrium: a unique Nash equilibrium is both choosing Low pricing strategies with 0 profits.
ii) When Ford moves as a first mover, and GM moves as a second mover, what is the sequential Nash
equilibrium? Does the second mover have any advantage over the first mover? Explain why or why not.
(Game ends when GM makes decision) (5 points)
Ford
GM
GM
High Pricing
Low Pricing
High Pricing
High Pricing
Low Pricing
Low Pricing
(200,200)
(100, 300)
(300, 100)
(
0,0
)
O Sequential Nash Equilibrium: Ford; Low Pricing, Ford: Low Pricing with payoff (0, 0) to Ford and GM.
O In this sequential game, neither the first mover, nor the second mover has any strategic advantage comparing
1
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View Full Documentto the simultaneous strategic game with the given payoff structure.
If a strategic game has multiple equilibria like the chicken game, when we transform the game into
sequential game, the first mover has the strategic advantage. However, if a game has a single equilibrium,
even after the game is transformed into a sequential game, the equilibrium is not changed as in this case
with no first mover advantage.
iii) When the game is infinitely repeated and each player chooses the trigger strategy, if GM makes the
commitment to choose the cooperative strategy, is the commitment credible? Why or why not? (5 points)
o GM’s commitment is credible in an infinitely repeated game.
O Why?; A commitment can be credible only when the committed strategy is a dominant strategy, and in infinitely
repeated game with trigger strategy taken by both players, cooperative strategy is a dominant strategy.
2. Assume that Microsoft (MS) is a monopolist in supplying computer Operating System software (OS
SW). The demand curve of the OS SW is given as: Q
D
= 1,000 – 2P
The long run average cost (LRAC) of MS is given as: LRAC = 400 – (Q/4)
The marginal cost of producing each unit of OS SW is: MC = 10
i) Assume that the regulation by San Diego government can be explained by social interest theory.
What are the level of price cap the government should impose and the resulting output level for the
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 Spring '08
 Kim
 Economics, Deadweight Loss, Monopoly, Supply And Demand, Externality

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