Extra Practice Questions for Exam 3



Extra Practice Questions for Exam 3

1. Two firms, Nike and Reebok, are competing with one another by choosing price. Each firm can choose a high price or a low price. The payoffs are depicted below.

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Suppose the game is played once. Is there an equilibrium?

a. Yes, there is a unique equilibrium, (high price, high price).

b. Yes, there are two, (low price, high price) and (high price, low price).

c. Yes, there are two, (low price, low price) and (high price, high price).

d. Yes, each of the four possibilities is an equilibrium.

e. No.

2. The firms of the last question will always charge the same price in equilibrium if the game is played once. True or false?

a. False.

b. True.

3. Suppose the game of the last two questions lasts forever. Each firm chooses its price each period and that information is revealed to the other firm next period. Suppose both companies' strategy is "always choose a low price." Calculate Reebok's payoff if both play this strategy. Let β be the discount factor.

4. Given the information of the last three questions, if both companies choose "always pick a low price" as their strategy, is this an equilibrium of the pricing game?

a. Yes.

b. No.

5. A monopolist that experiences increasing returns to scale will always earn an economic profit.

a. True because P > AC.

b. True because P > MC.

c. False because MR < P.

d. False because P < AC can occur even if returns to scale are increasing.

e. True because increasing returns to scale implies that P > AC.

6. Consider a monopolist who experiences increasing returns to scale. The government attempts to induce competition by breaking up the monopolist. Will it succeed?

a. Yes, competition will result in greater output and a lower price.

b. Yes, however, competition will result in a lower price but not necessarily more output.

c. Yes, however, competition will result in more output but will not necessarily generate a lower price.

d. No, because competitive firms will be unable to earn a normal rate of return.

e. No, because competitive firms will be unable to earn economic profits.

7. Consider a possible trading situation between two economic agents, A and B. There are two goods, X and Y, and the endowment point is point e in the diagram. Person A has preferences of the usual sort while person B has "Leontief" or "L-shaped" indifference curves as depicted in the Edgeworth Box diagram. Demonstrate what the eventual equilibrium will look like if both agents trade competitively.

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8. Income inequality has increased in the United States since 1980 in the sense that the gap between the rich and the poor has increased. True or false?

a. True.

b. False.

9. How do a private good and a public good differ?

10. Consider a situation where an externality has occurred. Should the government intervene?

a. The government should only intervene if the externality is harmful.

b. The government should only intervene if the externality is non-pecuniary in nature.

c. The government should intervene if the externality is non-pecuniary in nature or if the externality has adverse consequences for the income distribution.

d. The government should only intervene if the situation involves moral hazard.

e. The government should only intervene if the externality is beneficial.

Answers

1. c

2. b

3. π(Reebok) = 1 + 1β + 1β2 + ..... = 1/(1-β)

4. a. Suppose Reebok deviates on the first move and then goes back to the original strategy. Its payoff is - 1 + 1β + 1β2 + 1β3 + ...... = - 1 + β(1 + β + β2 + ..) = - 1 + β/(1 - β) and this is smaller than its payoff if it doesn't deviate. (Show that : 1/(1-β) > - 1 + β/(1-β) using algebra.

5. d.

6. d.

7. Agents will trade from point e to point c* where the two indifference "curves" touch at the price line through e and c*. A gives up some Y to get more X and vice versa for B.

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8. a.

9. For a private good, everyone pays the same price but consumes different qualities. For a public good, everyone consumes the same quantity but are willing to pay different amounts.

10. c.

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