Solutions to Topic 11: Oligopoly

Question 11.1              

The common feature in monopoly, oligopoly, and monopolistic competition is

        A)           the absence of close substitutes.

        B)            blocked entry.

        C)            interdependent decision making by firms.

        D)           price discrimination.

        E)            downward sloping demand.

•          The correct answer is (e).

•          In monopoly, monopolistic competition and oligopoly, firms have at least some market power and can set price over a range of output.

•          Thus the demand curve is downward sloping.

Question 11.2

Refer to the table (in your notes) which shows the payoff matrix of two firms, Firm A and Firm B, each has two strategies, to set high price or low price. The figures in the matrix show the profits earned by each firm.

(a)  Solve for the Nash equilibrium in this game.

(b)  Is this game a prisoner’s dilemma game?  Justify your answers.

(a)  The Nash equilibrium is both firm set high price and that the payoff to Firm A is $100 and pay off to Firm B is $75.

(b)  This is a prisoner’s dilemma game. The reason is that the Nash equilibrium is not the best outcome.  The best outcome is in fact both firms set low price so that Firm A gets $150 and Firm B gets $300

Question 11.3

The table (in your notes) shows the payoff matrix for players A and B to strategies X and Z.

Player A finds that

        A)           strategy Z is a dominated strategy.

        B)            strategy X is a dominant strategy.

        C)            strategy Z is a dominant strategy.

        D)           he has no dominant strategy.

        E)            his best strategy depends on what player B chooses.

The correct answer is (c)

If Player B chooses X, Player A will choose Z since $500 is better than $300.

If Player B chooses Z, Player A will choose Z since $1000 is better than $200.

Thus strategy Z is a dominant strategy for Player A.

Question 11.4

(1) Why is there no incentive for a firm in the kinked demand curve model to change its price?

(2) Is the price always remain rigid in the kinked demand curve model

(1) In the kinked demand curve model, the price is stabilized at the kink level.  If the firm charges a higher price, its demand becomes elastic and its revenue drops.  If it charges a lower price, its demand becomes inelastic and its revenue drops.  Thus it has no incentive to change the price.

(2) If there is a large change in the marginal cost such that the MC shifts by a larger amount than can be accommodated by the gap of MR, then the equilibrium price will change.