1. Deviating from the collusive outcome Mays and Mccovey are beer-brewing companies that operate in a duopoly (two-firm oligopoly). The daily marginal cost (MC) of producing a can of beer is constant and equals $0.80 per can. Assume that neither firm had any startup costs, so marginal cost equals average total cost (ATC) for each firm. Suppose that Mays and Mccovey form a cartel, and the firms divide the output evenly. (Note: This is only for convenience; nothing in this model requires that the two companies must equally share the output.) Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and combined quantity of output if Mays and Mccovey choose to work together. 2.00 1.80 Monopoly Outcome 1.60 Demand 1.40 1.20 1.00 PRICE (Dollars per can) MC = ATC 0.80 0.60 0.40 0.20 MR 0 40 80 120 160 200 240 280 320 380 400 QUANTITY (Cans of beer)when they act as a profitmaximizing cartel, each company will produce |:|cans and charge per can. Given this information, each rm earns a daily prot 0- , so the daily total industry prot in the beer market is . Oligopolists often behave noncooperatiyely and act in their own selfinterest even though this decreases total prot in the market. Again, assume the two companies form a cartel and decide to work together. Both rms initially agree to produce half the quantity that maximizes total industry profit. Now, suppose that Mays decides to break the collusion and increase its output by 50%, while McCovey continues to produce the amount set under the collusive agreement. Mays's deviation from the collusive agreement causes the price of a can of beer to V to per can. Mays's prot is now , while McCovey's prot is nowI . Therefore, you can conclude that total industry prot V when Mays increases its output beyond the collusiye quantity. 2. Breakdown of a cartel agreement Consider a town in which only two residents, Shen and Valerie, own wells that produce water safe for drinking. Shen and Valerie can pump and sell as much water as they want at no cost. For them, total revenue equals profit. The following table shows the town's demand schedule for water. Price Quantity Demanded Total Revenue ( Dollars per litre) (Litres of water) (Dollars) 6.00 0 0 5.50 45 $247.50 5.00 90 $450.00 4.50 135 $607.50 4.00 180 $720.00 3.50 225 $787.50 3.00 270 $810.00 2.50 315 $787.50 2.00 360 $720.00 1.50 405 $607.50 1.00 450 $450.00 0.50 495 $247.50 0 540 0 Suppose Shen and Valerie form a cartel and behave as a monopolist. The profit-maximizing price is |$ per litre, and the total output is litres. As part of their cartel agreement, Shen and Valerie agree to split production equally. Therefore, Shen's profit is | $ and Valerie's profit is $Suppose Shen and Valerie form a cartel and behave as a monopolist. The profit-maximizing price is | $ | per litre, and the total output is litres. As part of their cartel agreement, Shen and Valerie agree to split production equally. Therefore, Shen's profit is $ and Valerie's profit is $ Suppose that Shen and Valerie have been successfully operating as a cartel. They each charge the monopoly price and sell half of the monopoly quantity. Then one night before going to sleep, Shen says to himself, "Valerie and I aren't the best of friends anyway. If I increase my production to 45 litres more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow." After Shen implements his new plan, the price of water to $ per litre. Given Valerie and Shen's production levels, Shen's profit becomes | $ and Valerie's profit becomes | $ Because Shen has deviated from the cartel agreement and increased his output of water to 45 litres more than the cartel amount, Valerie decides that she will also increase her production to 45 litres more than the cartel amount. After Valerie increases her production, Shen's profit becomes $ , Valerie's profit becomes |$ and total profit (the sum of the profits of Shen and Valerie) is now $ True or False: Based on the fact that both Shen and Valerie increased production from the initial cartel quantity, you know that the output effect was larger than the price effect at that quantity. O True O False Note that Shen and Valerie started by behaving cooperatively. However, once Shen decided to cheat, Valerie decided to cheat as well. In other words, Valerie's output decisions are based on Shen's actions. This behaviour is an example of3. To advertise or not to advertise Suppose that Fizzo and Pop Hop are the only two firms that sell orange soda. The following payoff matrix/table shows the profit (in millions of dollars) each company will earn depending on whether or not it advertises: Pop Hop Advertise Doesn't Advertise Advertise 10, 10 18, 2 Fizzo Doesn't Advertise 2, 18 11, 11 For example, the upper right cell shows that if Fizzo advertises and Pop Hop doesn't advertise, Fizzo will make a profit of $18 million, and Pop Hop will make a profit of $2 million. Assume this is a simultaneous game and that Fizzo and Pop Hop are both profit-maximizing firms. If Fizzo decides to advertise, it will earn a profit of |$ million if Pop Hop advertises and a profit of $ million if Pop Hop does not advertise. If Fizzo decides not to advertise, it will earn a profit of |$ million if Pop Hop advertises and a profit of $ million if Pop Hop does not advertise. If Pop Hop advertises, Fizzo makes a higher profit if it chooses If Pop Hop doesn't advertise, Fizzo makes a higher profit if it chooses Suppose that both firms start off not advertising. If the firms act independently, what strategies will they end up choosing? Both firms will choose not to advertise. Fizzo will choose to advertise and Pop Hop will choose not to advertise. OFizzo will choose not to advertise and Pop Hop will choose to advertise. O Both firms will choose to advertise.Again, suppose that both firms start off not advertising. If the firms decide to collude, what strategies will they end up choosing? O Both firms will choose to advertise. OFizzo will choose not to advertise and Pop Hop will choose to advertise. OFizzo will choose to advertise and Pop Hop will choose not to advertise. O Both firms will choose not to advertise.4. Using a payoff matrix/table to determine the equilibrium outcome Suppose there are only two firms that sell smartphones, Flashfone and Pictech. The following payoff matrix/table shows the profit (in millions of dollars) each company will earn, depending on whether it sets a high or low price for its phones. Pictech Pricing High Low High 11. 11 2. 18 Flashfone Pricing Low 18, 2 10, 10 For example, the lower left cell shows that if Flashfone prices low and Pictech prices high, Flashfone will earn a profit of $18 million and Pictech will earn a profit of $2 million. Assume this is a simultaneous game and that Flashfone and Pictech are both profit-maximizing firms. If Flashfone prices high, Pictech will make more profit if it chooses a _ price, and if Flashfone prices low, Pictech will make more profit if it chooses V price. If Pictech prices high, Flashfone will make more profit if it chooses a _ price, and if Pictech prices low, Flashfone will make more profit if it chooses a V price. Considering all of the information given, pricing high a dominant strategy for both Flashfone and Pictech. If the firms do not collude, what strategies will they end up choosing? O Flashfone will choose a low price and Pictech will choose a high price. Flashfone will choose a high price and Pictech will choose a low price. O Both Flashfone and Pictech will choose a low price. O Both Flashfone and Pictech will choose a high price. True or False: The game between Flashfone and Pictech is an example of the prisoners' dilemma. O True O False5. Solving for dominant strategies and the Nash equilibrium Suppose Gilberto and Juanita are playing a game in which both must simultaneously choose the action Left or Right. The payoff matrix/table that follows shows the payoff each person will earn as a function of both of their choices. For example, the lower right cell shows that if Gilberto chooses Right and Juanita chooses Right, Gilberto will receive a payoff of 6 and Juanita will receive a payoff of 5. Juanita Left Right Left 8, 4 4, 5 Gilberto Right 5. 4 6, 5 The only dominant strategy in this game is for to choose The outcome reflecting the unique Nash equilibrium in this game is as follows: Gilberto chooses and Juanita chooses6. Collusive outcome versus Nash equilibrium Consider a remote town in which two restaurants, All-You-Can-Eat Cafe and GoodGrub Diner, operate in a duopoly. Both restaurants disregard health and safety regulations, but they continue to have customers because they are the only restaurants within 80 kilometres of town. Both restaurants know that if they clean up, they will attract more customers, but this also means that they will have to pay workers to do the cleaning. If neither restaurant cleans, each will earn $13,000; alternatively, if they both hire workers to clean, each will earn only $10,000. However, if one cleans and the other doesn't, more customers will choose the cleaner restaurant; the cleaner restaurant will make $18,000, and the other restaurant will make only $6,000. Complete the following payoff matrix/table using the previous information. (Note: All-You-Can-Eat Cafe and GoodGrub Diner are both profit- maximizing firms.) GoodGrub Diner Cleans Up Doesn't Clean Up Cleans Up $ All-You-Can-Eat Cafe Doesn't Clean Up $ $ If All-You-Can-Eat Cafe and GoodGrub Diner decide to collude, the outcome of this game is as follows: All-You-Can-Eat Cafe and GoodGrub Diner If both restaurants decide to cheat and behave noncooperatively, the outcome reflecting the unique Nash equilibrium of this game is as follows: All- You-Can-Eat Cafe and GoodGrub Diner