Question #1

Consider two firms, Firm 1 and Firm 2. Suppose the demands for these firms are respectively

Q1 = 100-P1+0.9P2

Q2 = 100-P2+0.9P1

Suppose the two firms' marginal costs are both $10. Using the Excel tools, we can show that, in equilibrium, P1=P2=$100, Q1=Q2=$90, and each firm earns $8100 of profit.

Due to successful process innovation Firm 1 manages to lower its marginal cost from $10 to $0 (!! I know this is incredible) and this is also made known to Firm 2.

Note: It is unlikely to have such calculations in the exam. However, make sure you know how to predict such direct effects and strategic effects (e.g. positive or negative) intuitively. You can use the excel tools for the questions below.

(1) Is the direct effect of the cost reduction positive or negative? How much is it? (2) Is the strategic effect of the cost reduction positive or negative? How much is it?

Question #2

Two agents from different departments, David and Anne, are put together to work on a one-time project. They must each independently decide whether to work hard or shirk. The project will succeed as long as at least one team member works hard, but will fail if both shirk. If the project succeeds, David and Anne each get a $200 bonus; if the project fails, they receive no money at all.

(1) Suppose that if an agent chooses to work hard it costs him/her $210, while shirking costs nothing. Describe what each agent's effort choice is and what the payoff is.

	David
Anne		Work Hard	Shirk
Work Hard	-10 -10	-10 200
Shirk	200 -10	0 0

(2) Suppose instead David and Anne are to work together in similar projects once a month on a long-term basis. The success of each of these projects requires at least one of them to work hard, and the partners each will be paid $200 for every successful project. Suppose the partners cannot pay each other part of the bonuses they receive from the company. Can they do better in this repeated-game setting? What is the best possible outcome that they can achieve? How?

Question #3

Read the case about Netflix and the WSJ article "Netflix Signals No Acquisition Plans" (July 20, 2021; available on Canvas). In the market of digital video delivery, what strategies do you think Netflix should do? Please write down your suggestions and provide brief justifications. Do not use other online sources of information or reports.