2. Breakdown of a cartel agreement

Consider a town in which only two residents, Sean and Yvette, own wells that produce water safe for drinking. Sean and Yvette 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 gallon)	(Gallons 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 Sean and Yvette form a cartel and behave as a monopolist. The profit-maximizing price is ($?)per gallon, and the total output is (?) gallons. As part of their cartel agreement, Sean and Yvette agree to split production equally. Therefore, Sean's profit is($?), and Yvette's profit is($?).

Suppose that Sean and Yvette 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, Sean says to himself, "Yvette and I aren't the best of friends anyway. If I increase my production to 45 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow."

After Sean implements his new plan, the price of water (increased or decreased?) to ($?) per gallon. Given Yvette and Sean's production levels, Sean's profit becomes ($?) and Yvette's profit becomes ($?).

Because Sean has deviated from the cartel agreement and increased his output of water to 45 gallons more than the cartel amount, Yvette decides that she will also increase her production to 45 gallons more than the cartel amount.

After Yvette increases her production, Sean's profit becomes ($?), Yvette's profit becomes ($?), and total profit (the sum of the profits of Sean and Yvette) is now ($?).

True or False: Based on the fact that both Sean and Yvette increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity.

True

False

Note that Sean and Yvette started by behaving cooperatively. However, once Sean decided to cheat, Yvette decided to cheat as well. In other words, Yvette's output decisions are based on Sean's actions.

This behavior is an example of which of the following?

1. Tying
2. A tit- for tat strategy
3. A prisoners dilemma
4. A dominant strategy

4. 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 shows the profit (in millions of dollars) each company will earn depending on whether or not it advertises:

	Pop Hop
Advertise	Doesn't Advertise
Fizzo	Advertise	10,10	18,2
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( to advertise or not to advertise?).

If Pop Hop doesn't advertise, Fizzo makes a higher profit if it chooses ( to advertise or not to advertise ?).

Suppose that both firms start off not advertising. If the firms act independently, what strategies will they end up choosing?

1. Fizzo will choose to advertise and Pop Hop will choose not to advertise.
2. Both firms will choosenot to advertise.
3. Both firms will choose to advertise.
4. Fizzo will choose not to advertise and Pop Hop 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?

A)Both firms will choosenot to advertise.

B)Fizzo will choose not to advertise and Pop Hop will choose to advertise.

C)Fizzo will choose to advertise and Pop Hop will choose not to advertise.

D)Both firms will choose to advertise.

5. Using a payoff matrix to determine the equilibrium outcome

Suppose there are only two firms that sell smartphones: Flashfone and Pictech. The following payoff matrix 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
Flashfone Pricing	High	11,11	3,15
Low	15,3	9,9

For example, the lower-left cell shows that if Flashfone prices low and Pictech prices high, Flashfone will earn a profit of $15 million, and Pictech will earn a profit of $3 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 (HIGH or Low?) price, and if Flashfone prices low, Pictech will make more profit if it chooses a (High or low?) price.

If Pictech prices high, Flashfone will make more profit if it chooses a (HIGH or Low?) price, and if Pictech prices low, Flashfone will make more profit if it chooses a (HIGH or Low?) price.

Considering all of the information given, pricing low (IS or IS not ?) a dominant strategy for both Flashfone and Pictech.

If the firms do not collude, what strategies will they end up choosing?

a) Both Flashfone and Pictech will choose a low price.

b) Flashfone will choose a low price, and Pictech will choose a high price.

C) Flashfone will choose a high price, and Pictech will choose a low price.

D) 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.

True

False

6. Solving for dominant strategies and the Nash equilibrium

Suppose Alex and Becky are playing a game in which both must simultaneously choose the action Left or Right. The payoff matrix 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 Alex chooses Right and Becky chooses Right, Alex will receive a payoff of 5 and Becky will receive a payoff of 5.

	Becky
Left	Right
Alex	Left	6,6	6,3
Right	4,3	5,5

The only dominant strategy in this game is for (Becky or Alex?) to choose (Left or Right?).

The outcome reflecting the unique Nash equilibrium in this game is as follows: Alex chooses (Left or right?) and Becky chooses (Left or right?).

7. 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 miles 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 $11,000; alternatively, if they both hire workers to clean, each will earn only $8,000. However, if one cleans and the other doesn't, more customers will choose the cleaner restaurant; the cleaner restaurant will make $16,000, and the other restaurant will make only $4,000.

Complete the following payoff matrix using the information just given. (Note: All-You-Can-Eat Cafe and GoodGrub Diner are both profit-maximizing firms.)

	GoodGrub Diner
Cleans Up	Doesn't Clean Up
All-You-Can-Eat Cafe	Cleans Up	($?,$? )	($?,$? )
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 (CLEAns OR Dose not Clean?)and GoodGrub Diner (CLEAns OR Dose not Clean?).

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 (CLEAns OR Dose not Clean?), and GoodGrub Diner (CLEAns OR Dose not Clean?).