Econ 100A Ans to PS5

Econ 100A Ans to PS5 - Department of Economics University...

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Econ 100A-Spring 2010 Page 1 Problem Set 5 Answers Department of Economics Spring 2010 University of California Prof. Woroch Economics 100A PROBLEM SET 5 ANSWER SHEET I. TRUE or FALSE of UNCERTAIN and EXPLAIN : For each statement below, decide whether it is true or false or cannot be determined, and explain the reasoning behind your answer in a few sentences. Supply any assumptions you feel are needed to come to your conclusion. 1. According to the Stackelberg model, the dominant firm allows the follower to produce a positive amount because it is not possible to completely exclude him from the market. False/Uncertain: According to the Stackelberg model as presented in class, the follower is already in the market (not an entrant) and possibly with sunk fixed costs (and hence low avoidable variable costs), so that it may be difficult for the market leader to produce a quantity high enough to cause the follower not to produce. Even in the case where the follower is an entrant not yet in the market, the leader may find it more profitable to accommodate than to exclude (even though exclusion is possible). 2. When two duopolists compete by setting price for their products, then the industry will result in the Bertrand paradox. Uncertain: If the two firms produce differentiated products, then the Bertrand paradox would not occur. If the two firms have the same marginal costs, the firms will compete by driving prices down to that marginal cost. Suppose that firm 1 has a higher marginal cost. Firm 2 can then “stop” lowering prices at the MC 1 . Firm 2 will make (P – MC 2 ) = (MC 1 – MC 2 ) on each unit. 3. Concerned with the waste associated with product proliferation, the government could reduce the number of brands in a monopolistically competitive industry by placing a lump-sum tax on each firm. True: Since in a monopolistically competitive industry, firms enter as long as they can cover their fixed costs, raising that fixed costs deters entry. More specifically, if an industry has constant marginal costs, AC = MC + F/Q. Firms enter if AC > 0. Thus, a lump sum tax increases F, pushing the AC curve out and up, making it more difficult for firms to introduce additional products. 4. If firms in the competitive fringe have higher cost than the dominant firm, it makes sense for the dominant to set price so as to drive out all the fringe firms. Uncertain. Depends on the nature of the cost. If the competitive fringe has high fixed costs that are sunk, then charging lower prices would not drive out the fringe. Accommodation is more profitable. The dominant firm would produce the output where MR of the residual demand curve is equal to its MC. If the dominant firm has lower marginal costs and if profits earned after driving out the fringe are positive then pricing to drive out the fringe would be a credible strategy. 5.
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Econ 100A Ans to PS5 - Department of Economics University...

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