QUESTIONS

1. Outline, evaluate, and contrast the Bertrand and Cournot approaches to oligopoly with
differentiated products. - homogenous olarak sorabilir.

2. A Nash Equilibrium occurs where a player maximises their payoff given what they anticipate their
opponent is doing. True/false/Uncertain. Explain it.

3. The Bertrand oligopoly model suggests a reason for the large amounts Cola-Turka, Coca-Cola and
Pepsi spend on advertising. True/false/Uncertain. Explain it.

4. An American firm and a British firm are the sole competitors in the European market for some
homogeneous good. Competition takes place as in the Cournot model. Suppose the dollar
appreciates with respect to the pound. Using reaction curve, analyse how this affect the market
share of each firm.

5. Suppose a foreign and a domestic firm compete in quantities in Turkish market. Using reaction
curves, analyse how a government-imposed quota on the amount the foreign firm can sell affects
the equilibrium. Under what conditions, if any, could the quota induce exit of the foreign firm?

6. Suppose that the doupolists competing in Counot fashion agree to produce collusive output. given
that firm 2 commits to this collusive output, it pays firm 1 to
a) cheat by producing a lower level of output. b) cheat by producing a higher level of output.
c) cheat by raising prices. d) none of the above.

7. Suppose that the market demand function is Q=20-P and each of two duopolists have constant
marginal costs. Firm 1 has marginal cost of 10 and firm 2 has marginal cost of 6. If firm2 is a
Cournot duopolist, how much will that firm produce?

8. A firm is quite happy monopolizing its industry with profits of $10M. A potential competitor
considers entering the industry. If the competitor elects not to enter, it earns profits of $0 and the
monopolist maintains its profit of $10M. If the competitor enters, the monopolist must either
accommodate the entry or fight. If the monopolist accommodates, both firms earn $5M. If the
monopolist fights, both firms lose $5M. What is the rollback equilibrium of the above game?

9. Consider the following three-move game, in which player 1 moves twice. This is the two-person
game in extensive-form. The top of payoff in the pair of payoffs at the end of each branch of the
game tree is player 1’s, the bottom player 2’s. What is the perfect equilibrium outcome? Explain
your reasoning. (Player: i=1,2 ; Strategies:L,L)

1
R
L 2
R
L 1
2 R
0 L
1
1 0
3 2
0
1
10. Consider a market with two firms and the following attributes demand curve: Q = 120 – 4P
marginal costs: MC = 0 for both firms fixed costs: FC = 0 for both firms
a) If the two firms compete over quantities, what are the corresponding quantities and profits
for each firm if the game is played once? (Derive mathematically)
b) If the two firms decide to collude and charge the monopoly price, what are the
corresponding quantities and profits for each firm?
c) If one firm decides to cheat on this agreement (splitting the monopoly quantity), what
quantity will that firm produce? What will be the corresponding profits for both firms?

11. Assume that there are i  1, 2,..., n identical firms in an industry, each with constant marginal
costs of c and no fixed costs. If the market price P , is determined by the equation P  a  Q ,
where Q is total output of the industry and “ a ” is a constant, determine the Cournot-Nash
equilibrium output level for each firm. (Use Q i to denote aggregate output of all firms excluding i
th
firm’s output)

12. Now consider the following 2-stage game. In stage 1, each firm decides to ‘Enter’ (in which case it
pays a very small sunk cost 0) or ‘Don’t Enter’. In stage 2, if one firm has entered he acts as a
monopolist facing the market demand schedule (p=1-q); if both firms enter they play the Bertrand
game described in part (a). Describe the perfect Equilibrium outcome of this 2-stage game.

13. Consider a Cournot duopoly (i.e. a market in which two firms offers an identical product; and
where the strategy chosen by each firm is its output level. Payoffs are determined by equating total
output with market demand, to determine price.)
Market demand is described by: P= a – b.Q Q= (q1 + q2)
The firms have cost schedules C1=  + 1 q1 for firm 1 and C1=  + 2 q2 for firm 2

Show that for given parameters, there is unique Nash Equilibrium ( q *1 , q *2 ) at which:
1
q *1  ( a  2 1   2 )
3b
 1 4 *  1 2 *
Show also that  q1 ;  q1
 1 3  2 3

We have the following information

Q = 100 – 0.5P or P = 200 – 2Q or 200 – 2(q1 + q2) Where Q = q1 + q2

Total cost of Firm 1 (C1) = 80q1
Total cost of Firm 2 (C2) = 80q2
The profits of the duopolists are

Π1 = Pq1 – C1 = [200 – 2(q1 + q2)]q1 – 80q1

Π1 = 200q1 – 2q21 – 2q1q2 – 80q1
Π1 = 120q1 – 2q21 – 2q1q2
Π2 = Pq2 – C2 = [200 – 2(q1 + q2)]q2 – 80q2
Π2 = 200q2 – 2q1q2 – 2q22 – 80q2
Π2 = 120q2 – 2q1q2 – 2q22
For profit maximization under the Cournot assumption we have

∂Π1/∂q1 = 0 = 120 – 4q1 – 2q2

∂Π2/∂q2 = 0 = 120 – 4q2 – 2q1
The reaction functions are

2
q1 = 30 – 0.5q2
q2 = 30 – 0.5q1
Replacing q2 into the q1 reaction function we get
q1 = 30 – 0.5(30 – 0.5q1)
q1 = 30 – 15 + 0.25q1
0.75q1 = 15
q1 = 20
And

q2 = 30 – 0.5q1
q2 = 30 – 0.5(20)
q2 = 20
Thus, the total output in the market is
Q = q1 + q2 = 20 + 20 = 40
And the market price

P = 200 – 2(q1 + q2)

P = 200 – 2(20 + 20)

P = 200 – 80

P = 120
The profits of the duopolists are

Π1 = pq1 – C1
Π1 = (120 × 20) – 80(20)
Π1 = 2400 – 1600
Π1 = 800
And

Π2 = pq2 – C2
Π2 = (120 × 20) – 80(20)
Π2 = 2400 – 1600
Π2 = 800
The second order condition is satisfied for both the duopolists

∂Π1/∂q1 = 0 = 120 – 4q1 – 2q2

∂2Π1/∂q21 = – 4 < 0
∂Π2/∂q2 = 0 = 120 – 4q2 – 2q1
∂2Π2/∂q22 = – 4 < 0

14. Suppose that a company called Fast-Cleaner currently dominates the market and makes $300,000
per year, and we are considering starting a competing company. If we enter the market, Fast-
Cleaner will have two choices: accept the competition or fight a price war. Suppose that we have
done market analyses from which we expect that if Fast-Cleaner accepts the competition, each firm
will make a profit of $100,000 (the total is less than Fast-cleaners alone used to make because it
could enjoy monopoly pricing). However, if Fast-Cleaner fights a price war, they will suffer a net
loss of $100,000, and we will lose $200,000. (Note that these are the ultimate payoffs, not just

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 temporary gains or losses that may change over time.). Write this game in extensive form and
solve it.

15. The deities Mars and Venus often do battle to create the weather conditions on Earth. Venus
prefers extreme temperatures (especially heat), while Mars prefers temperate conditions. The
payoffs (expressed in Points of Wrath) are given below.

    Venus
    Warm Chill
Chill
20 , 0 0 , 10
Mars
Warm 0 , 90 20 , 0

What is the unique mixed-strategy equilibrium of the above game?

Let p be the probability of "Warm" for Mars, and q the probability of "Warm" for Venus. In the above
game, who earns more Points of Wrath (on average) in equilibrium, Mars or Venus?

16. A robber (R) has seen a potential victim and is trying to decide whether to attack (A) or pass (P). If
he attacks, then the victim (V) has to decide whether to Fight (F) or yield (Y). If he does not attack
then both the robber and the victim receive a payoff zero. If he attacks and the victim yields the
robber gets v dollars from the victim; if she resists, however, the robber can get only v/2 dollars and
both pay the cost of fight, which we assume to be equivalent to c dollars. (Assume that c > v/2 > 0)
a) Draw the extensive form game and find the equilibrium of the game.
b) Find the pure strategy Nash equilibrium of the normal form of game.
P
17. Suppose that the market demand is given by, Q  100  where Q  q1  q2 . There are two
2
identical firms with the same total cost function, TC  qi   80qi . The two firms decide their
quantities of production simultaneously, taking the opponent’s strategy/quantity as given (the
Cournot market structure)

a) Write down the profit maximization problems of the two firms and derive their reaction
functions.
b) Find the Cournot-Nash Equilibrium.
c) Find the market price and profits of the firms under Cournot-Nash Equilibrium

18. In Harry and Lloyd are two fishermen. They currently fish in a small pond that is well-stocked with
fish, so that each of them catches 5 lbs worth of fish every trip. They both hear of a pond with a 20
lb prize-winning fish in it. If they both change to the new pond and fish there, the fish will not bite
(it’s a very smart fish), and they will go home empty-handed. However, if one of them fishes the
new pond, he will catch the big fish and the other fisherman, who stayed at the current pond, will
catch 10 lbs worth of fish at the old pond. They both would rather catch the prize-winning fish,
obviously, but the fish is very smart and will not fall for two lures in the pond at the same time.
a. Set up the appropriate game if Harry and Lloyd make their decisions simultaneously.
b. What type of game is this?

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 c. Assume the game above is one-shot. Find all equilibrium

19. If 2 spiders find a dead insect at the same time, each spider will make menacing gestures to scare
off the other. If one spider backs down, that spider gets nothing and the other spider gets the insect
to itself. If both spiders back down, they can share the insect. If neither backs down, the spiders will
fight. The payoffs resulting from the fight depend on the sizes of the spiders and are described
below.

    Spider 2
Back
    Fight
down
Back
5 , 5 0 , 10
Spider 1 down
Fight 10 , 0 x , y

Suppose the spiders are the same size so that x=y. For what values of x, will each spider have a
dominant strategy? In this case, what is the Nash Equilibrium?

20.Consider the strategic-form game represented by the following matrix:

Player 2
L R
T (6,6) (2,8)
B (8,2) (0,0)

Player 1 chooses between T and B and receives the payoff in the bottom-left corner of the cells.
Player 2 chooses between L and R and receives the payoff in the top-right corner of the cells.
Choices are made simultaneously.
(a) What are the Nash equilibria (including any mixed) of this game, and what are the players’
expected payoffs in each equilibrium?
(b) Suppose a single (fair) coin is tossed, the outcome of which is publicly observed. If it is
heads player 1 is told to play T, and player 2 is told to play R; if it is tails, player 1 is told to
play B, and player 2 is told to play L. Would each player be willing to follow these
instructions, given that the other player did so? What would be the expected payoffs?
Comment.

21. Refer to the following payoff matrix for questions 2.1 and 2.2:

Player 2
C1 C2 C3
Player 1 R1 (12,3) (6,2) (9,2)
R2 (8,5) (10,4) (10,6)

2.1. How many Nash Equilibria are there?

a) 0 b) 1 c) 2 d) 3 e) none of above/not enough information
2.2. What will Player 1’s payoffs be in equilibrium?
a) 6 b) 8 c) 10 d) 12 e) none of above/not enough information

22. Two firms compete by setting either a high or low price (H and l respectively). In each period they
set prices simultaneously. The one period payoff matrix is given by
Firm 2
High price Low price

5
 Firm 1 High price (6,6) (1,8)
Low price (8,1) (4,4)

Compute the Nash Equilibrium if the game is played once.

23. Two players, Jack and Jill, are put in separate rooms. Then each is told the rules of the
game. Each is to pick one of six letters: G, K, L, Q, R, or W. If the two happen to choose the
same letter, both get prizes as fallows:

Letter G K L Q R W
Jack’s prize 3 2 6 3 4 5
Jill’s prize 6 5 4 3 2 1

If they choose different letters, each gets 0. this whole schedule is revealed to both players, and
both are told that know the schedules, and so on. Draw the table for this game. What are the Nash
equilibria in pure strategies?

24. Two firms produce homogeneous outputs with cost functions

C1= (q1)2 C2= 2(q2)2

And the inverse demand function

P= 100 – ( q1 + q2 )

Show that at the Cournot-Nash equilibrium firm2 makes higher profit than the joint-profit maximizing
equilibrium.
(Hint: i-Find joint profit maximizing equilibrium outputs for firm1 and firm2, joint profit maximizing
equilibrium profits for firm1 and firm2 and joint profit maximizing equilibrium price; ii-Find Cournot-Nash
equilibrium outputs for firm1 and firm2, Cournot-Nash equilibrium profits for firm1 and firm2 and Cournot-
Nash equilibrium price)

25. (Bertrand Equilibrium). Two firms i=1,2 produce an identical product subject to marginal cost ‘c’. Market
demand is given by q=1-p. The strategy of firm i is to set price p 1c. The payoff to firm 1 is

  (p1 – c)(1 – p1)  if p1 p2

  1/2 (p1 – c)(1 – p1)  if p1= p2
0  if p1 p2
and similarly for firm 2.

(a) Prove that the unique Nash Equilibrium is p1= p2=c.

(b) Now consider the following 2-stage game. In stage 1, each firm decides to ‘Enter’ (in which case it pays
a very small sunk cost 09 or ‘Don’t Enter’. In stage 2, if one firm has entered he acts as a monopolist
facing the market demand schedule (p=1-q); if both firms enter they play the Bertrand game described
in part (a). Describe the perfect Equilibrium outcome of this 2-stage game.

(c) What differences does it make in question (b) if we assume that the 2 firms play Cournot (i.e. we seek
a Nash Equilibrium in quantities at the second stage).

26. In the game shown below, identify the unique Nash Equilibrium. Now consider a different game, in which
player 1 first choose a strategy, and then player 2, knowing player1’s choice, picks his strategy. What is the
equilibrium in this leader-follower (Stackelberg) game? What is the equilibrium in the game where player 2 makes
the first move?

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 Left Right
Up (6,4) (3,5)
Down (5,3) (2,2