Lec6-Problems - Lecture 6: Additional Problems & Examples...

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Lecture 6: 1) Predatory pricing 2) Limit pricing 4) Raising rivals’ costs Problem #1 (Cartel duopoly) Suppose there two firms making an identical product with a market demand of P = 250 – 2Q. Each firm has a constant average and marginal cost of production of $5 a unit. A) Suppose these firms decide to form a Cartel. For each firm determine the resulting profit maximizing level of output, price and level of profits. B) Suppose both firms decide to compete as Cournot duopolists. For each firm determine the resulting profit maximizing level of output, price and profits. C) Suppose the two firms agree to act as a Cartel. Use math and logic to show that Firm 1 has an incentive to cheat on this agreement. That is, show that it is Firm 1’s best interest to agree to behave as a Cartel and then to turn around and cheat on the Cartel agreement. D) Fill in a 2x2 table with the payoffs for the choices the two firms’ face - where they could either cooperate (act as a Cartel) or cheat (cheat on the agreement). What is the Nash equilibrium solution of this game? Explain why this outcome makes sense. Problem #2 (Problem #1 revised) A) How does your answer to Problem #1 above differ, if at all, if the firms decide to compete via Bertrand price picking? Explain. B) How does your answer to Problem #1 above differ, if at all, if the firms have asymmetric costs? Does it matter if this asymmetry is with respect to marginal or fixed costs? Explain. C) How does your answer to Problem #1 above differ, if at all, if the firms operate in a repeated game environment? Explain. Hint: This is not a once and for all game, but instead it happens over and over again in many future periods. 1 | P a g e
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Problem #3 (Problem #1 revised again) Suppose there two firms making an identical product with a market demand of P = 250 – 2Q. Each firm has a constant average and marginal cost of production of $5 a unit. A) Show that if the firms compete by picking output then each firm has an advantage by picking first. Explain how and why this first mover advantage exists. Explain exactly how you have defined and measured a first mover advantage. B) Suppose Firm 1 proposes the two firms create a Cartel. As an act of good faith Firm 1 has already made their share of the Cartel’s joint level of output (i.e. this is the first move in the game). Show that Firm 2 has an advantage (created) by picking second. Explain how and why this second mover advantage exists. Explain exactly how you have defined and measured a second mover advantage.
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This note was uploaded on 02/05/2011 for the course ECM 41 taught by Professor Jackparkinson during the Summer '10 term at University of Toronto.

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Lec6-Problems - Lecture 6: Additional Problems & Examples...

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