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Your name: ____________________________________ MICHIGAN STATE UNIVERSITY Department of Economics Econ 460 Prof. Boyer Spring 2007 Second Midterm Exam Answer any eight of the following eleven questions. All questions are 10 minutes and worth 8 points: 1) Consider the following matrix for two local grocery stores in a small town. Figures in parentheses show (profits for Firm A, profits for firm B.) They have each developed two strategies: offer double coupons or stay open 24 hours to help increase sales. Does either firm have a dominant strategy? (2 points) Explain how you can tell (2 points.) Is there a Nash equilibrium? (2 points) Explain how you can tell (2 points.) Firm B uses double coupons Firm B stays open 24 hours Firm A uses double coupons (40,60) (55,45) Firm A stays open 24 hours (45,55) (60,40) For firm A, stay open 24 hours is a dominant strategy because 45>40 and 60>55. For firm B, Use Double Coupons is a dominant strategy because 60>45 and because 55>40. Yes there is a Nash equilibrium which in this case is the pair of dominant strategies. It is a Nash equilibrium because if both firms use it, neither can make themselves better off by deviating from that strategy. 2) George Hay, in his chapter on cigarettes, rated entry barriers into the cigarette industry as very high. Nonetheless there has been considerable entry into the industry in the last ten years. Explain why the author considers entry barriers to be high in the cigarette industry (4 points) and reconcile this belief with the high level of entry that has occurred in this industry (4 points.) The student must mention brand loyalty or product differentiation to get full credit. If instead the student lists some of the other factors: access to distribution channels, a history of predation, or rapidly shrinking market size the student should get a maximum of 3 points for any two, or 2 points for one. The presence of entry barriers has encouraged cigarette companies to keep prices high. This has encouraged entry. (4 points for this explanation.) Alternatively, for full credit the student can talk about differing market segments (entry barriers are for premium brands only and entry has occurred in other segements) or that entry has been based on low-cost foreign production or that entry has been due to the distorted price structure resulting from the tobacco settlement.(Full credit for any of these explanations.) 3) Suppose that Boeing is a Stackelberg leader and Airbus is the follower in a duopoly and that industry demand and const conditions are: P = 60-2(q b + q a ) where b indexes Boeing and a indexes Airbus. MC b =10 and MC a =20. Assume that the fixed costs for neither firm enter into their decisions.

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