CHAPTER 13 Oligopoly  

Test Yourself

1.   The payoff matrix for GM might be Table 1:

               TABLE 1

            It is, of course, hard to tell what the entries in the payoff matrix will be.

2.     The sales-maximizing solution occurs at an output of 250,000 gallons, where marginal revenue is zero. At this output, total revenue is a maximum, $40,000. If the firm expanded to an output of 300,000 gallons, marginal revenue would be negative, and total revenue would fall to $36,000. The sales maximizing output is higher than the profit maximizing output of 150,000 gallons. To arrive at the latter, the firm set marginal revenue equal to marginal cost; since marginal cost is positive, marginal revenue had to be higher than zero, and (since marginal revenue has a negative slope) output was consequently lower.

3.   In Table 2, we can see that if Firm A chooses the Low-Tech option, Firm B would be better off choosing the High-Tech option since it would get a payoff of $12 million (vs. $10 million if it chooses Low-Tech). If Firm A chooses the High-Tech option, Firm B would be better off choosing the High-Tech option once again because it would get a payoff of $3 million (vs. 2$2 million for the Low-Tech option). Therefore, High-Tech is Firm B’s dominant strategy since it is the best strategy regardless of Firm A’s strategy

4.   Since it is a zero-sum game and A has lost 2 of its original payoff, B must have gained 2 and now will have a payoff of 8.

Discussion Questions

6.   This is an example of “predatory pricing.” Biggie hopes to set a price so low that Bargain will be unable to compete and be driven out of business. Furthermore, other potential entrants will be scared off. Biggie may actually suffer losses while this is happening. Eventually however, when Bargain has left, Biggie hopes to act like a monopolist and set a high price. This strategy will only be effective if Biggie can prevent new competitors from entering the market.

7.   If air transportation were perfectly contestable, Bargain could exit the industry while the price was low, use its assets on some other routes for a while, then return to the Eastwich-Westwich route when Biggie raised prices. So Biggie would never succeed in setting high monopoly prices.

9.   A single airline serving a community is not a pure monopoly. It is restricted from setting a monopoly price by the competition from other forms of transportation, such as cars, buses, and trains. Furthermore, the barriers to entry into the market are not absolute, so if the profits are sufficiently high the original airline is likely to face competition from another airline.

10. (a)  If Firm A is a “tough guy,” it will always strike back at hostile actions by Firm B, even if those hostile acts harm its own interests. Once B becomes convinced that this will happen, it may cease its hostile behavior against A, and A will benefit.

            (b)  If Firm A has a reputation for irrationality, Firm B may think it best to adopt a conservative strategy, not threatening A’s profits, lest A strike out against it even at a cost to itself. A may not do this, but B never knows.

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