Salvatore Chapter 10
Module 5: Critical Thinking 5
Arlena Gillespie
Liberty University
Disussion Question 2 a). adavnatages of Herfindahl index over concentration ratios in
measuring the degree of concentration in an industry? b) disadvantage of both?
The Herfindahl index utilizes information on all the firms in the industry versus only
using the market share of the largest 4,8,or 12 firms in the market. Squaring the market share of
each firm allots the association of a larger weight to larger than smaller firms in the industry. The
Herfindahl index also is more practical than concentration ratios as it has been adopted by the
Justice Department in 1982.
The disadvantage of both the Herfindahl index and concentration ratio are that neither
methodology focuses on contestable markets which is when entry is absolutely free and exiting is
entirely costless. Both methods do not equate competition with more concentration, or recognize
entry barriers. The Herfindahl index and the concentration ratio are also challenged by the
definition of “Relevant markets.”
Discussion Question 8 In what way does OPEC resemble a cartel? How successful is it?
OPEC attempted to implement the centralized cartel which is a formal agreement among
oligopolistic producers to set the monopoly price, allocate output among its members, and
determine how profits are to be shared. OPEC resembles a cartel as its seeks to increase the
earnings of petroleum for it members. OPEC has twelve oil exportation countries and exhibits
price leadership as they set the price as well as determine how much oil should be supplied to
stabilize prices.
OPEC optimized it’s price leadership structure as it increased prices drastically from
$2.50 to more than $40 a barrel in 1973. However, OPEC’s share of global oil production and its
share of world petroleum exports both decreased by 22% and 45%, respectively. With the
exception of Iraq’s invasion of Kuwait, OPEC’s petroleum prices remained under $20 a barrel in
the conditions of excess supply for nearly 14 years. Yet, OPEC has still managed to increase the
price of petroleum since 2000, reaching an all time high of $147 in 2008. Petroleum prices have
increased for several reasons of war, increase in consumption in areas such as China, the fear of
supply disruption from production facilities, and the political turmoil in Nigeria and Venezula.
OPEC has been unsuccessful and successful in it’s operating strategy to meet the global growing
demand of crude oil as the success of it’s petroleum prices vary on the strength of the global
demand in relative supply and politics of the petroleum exporting countries with the cooperation
of non-OPEC oil exporters.
Discussion Question 12 How did the 1971 law that banned cigarette advertising on
television solve the prisoners’ dilemma for cigarette producers? D12: Explain first the
prisoners' dilemma for cigarette producers before 1971 law. Use table 11-4, replace Low Price
with Advertise, and High Price with Don't Advertise. You would see this is similar to the
prisoners' dilemma.
Prior to the 1971 law, prisoner’s dilemma for cigarette producers was viewed as a
dominant strategy to cheat the competition in configuring a way to cut costs and sell more
product. In 1971, the law banned cigarette advertising which solve prisoners’ dilemma for
cigarette producers by reducing the expenditures of marketing and advertising while
increasing it’s profits. The implementation of the law was to generate more healthier choices
by reducing the smoking habits of society. However, the competition amongst the producers
of cigarettes was reduced as the law banned them from advertising.
Problem 1 a). three firms-one with 70% of the market, and the other two with 20% and
10% of the market, respectively; b) one firm with a 50% share of the market and 10 other
equal sized firms; c) 10 equal-sized firms P1: Use 70 instead of 70% in your Herfindahl
index calculation
2 2
Problem 5 Starting with the reaction functions of duopolists A and B from Problem 4, find
the Cournot solution algebraically.
H =70 + 20 +
102
H =502 +10
[(50/10)]2
H=10
(100/10)2
4900 + 400 + = 5,400
100
2500 + 2500 +10 2500 +
(52) (25) 250
10 (10)210 (100)= 1,000
Salvatore’s Chapter 11:
5400/100 = 54%
54
= 2750/100=27.27.5
2,750 5 %
1000/100 = 1010%
QA = (12-QB)/2
QB = (12-QA) /2
QA = (12- ((12-QA) / (2/2))
QA = (24- ((12-QA)) / (2/2))
QA = (24- 12 + QA) / (2/2))
QA = (12+QA )/4
4QA = 12 + QA
3QA = 12
QA = 4
QB = (12-4) /2
QB = 8/ 2
QB = 4
Q= QA + QB
Q = 4 + 4
Q = 8
Q = 12-P
8 = 12 -P
-4 = -P
4 = P
Discussion Question 13 A). What is the meaning for tit-for-tat in game theory? B) What
conditions are usually required for tit-for-tat strategy to be the best strategy?
Tit-for –tat game theory is recognized in repeated games involving many consecutives
moves and countermoves by each player which could mean cooperating as long as your
opponent cooperates.
It requires a reasonable stable set of players. There must be a small number of players.
Each firm must be able to quickly detect and retaliate for cheating by other firms. Demand and
cost conditions must be relatively stable because if they change rapidly, they are difficult to
define. It must be assumed the game is repeated indefinitely or at least a very large number and
uncertain number of times.
Problem 6 Explain why the payoff matrix in Problem 1 indicates that firms A and B
face the prisoners’ dilemma. P6: Correction: change the payoff cell (21,3) to (-1,3)
and (3,21) to (3,-1) in problem 1.
Problem 2 a)Whether firm A has dominant strategy b) Whether firm B has a
dominant strategy and C)the optimal strategy for each firm and d) the Nash
equilibrium, if one exist. P2: Correction: change the payoff cell (21,3) to (-1,3) and
(3, 21) to (3,-1).
Low Price
Firm B
High Price
Firm B
Low PriceHigh Price
Firm ALow Price(1,1)(3,-1)
High Price(-1,3)(4,2)
A ). The high Price strategy is the dominant strategy for Firm A when Firm A’s profits are 3, as
Firm B decides to change to the low price profits of -1. Firm A’s profits decrease to -1 if Firm B
adopts the strategy of high price. Therefore, the dominant strategy for Firm A is high price
regardless of the strategies adopted by Firm B.
B). The low pricing strategy is the dominant strategy for Firm B. As the low price for Firm B is 3
when the high price of Firm A -1 and Firm B earns a profit of 1 when Firm A earns 1. Therefore,
the dominant strategy for Firm B the low price strategy.
C). The Optimal strategy for each firm depends on the strategy selected by Firm A. Firm A will
opt for a high price strategy and the Firm B will opt for a low price strategy.
D). Nash equilibrium is the situation where each firm choose its strategy given the strategy
chosen by the other firm. Since the strategy of Firm B depends on Firm A, Firm B exhibits the
Nash equilibrium at (1,1).
Firm A
Firm A
Low Price
High Price
Low Price
High Price
(1,1)
(-1,3
)
Enter
(3,-1)
(4,5)
Firm B
(3,-1
)
(4,2)
Don’t Enter
(3,-1)
(6,3)
A). Firm A should choose a high pricing strategy, as profit remain the same whether Firm
A enter or doesn’t enter at 3 of the low pricing strategy. However, at a high pricing trategy
the profits increase for Firm A when it doesn’t enter the market.
Firm B incurs a loss at the low price of enter and not entering the market. On the other
hand, it earns a profit using the high pricing strategy in entering the market at 5 rather
than not entering at 3.
B). The reason is that Firm A earns a profit of 3 if it charges the low price and earns a profit
of 4
if charges the higher price. Unless Firm A makes a credible commitment to fight entry even
at
the expense of profits, it would not deter Firm B from entering the market.
C). An alternative to building excess capacity to make a credible threat coule be for Firm
Ato
cultivate a reputation for irrationality in deterring entryby charging a low price even if it
mean
lowering profits indefinitely.
If both firms cooperated, they both would charge a high price of 4 for Firm A and 2 for
Firm B. Both firms are in prisoner’s dilemma as each firm will charge the lower price and
earn a smaller profit because if it charges the higher price, it cannot trust its rivals to
also charge the high price.
Problem 10 A) indicate the best strategy for each firm. B) Why is the entry-
deterrent threat by firm A to lower the price not credible to firm B? C) What could
firm A do to make it’s threat credible without building excess capacity? P10(a):
Correction: change the payoff cell (3,21) to (3,-1). The strategies for firm A are low price
and high price and the strategies for firm B are enter and don't enter. What is the best
(optimal) strategy for each firm? P10(b) is asking whether firm A would use the low price
as a threat if firm B enters?
Froeb and McCann's Chapter 15:
Individual problems: 15-4 Salary Negotiation
Froeb and McCann's Chapter 10:
Individual problems: 10-4. Examine the US passenger airline industry using the Five
Forces. Is this an attractive industry? Why or Why not?
Bargaining Power of Customers
This is a low threat in this industry that has a large amount of customers
compared to the amount of firms and loyal customers to those firms. Swtiching
cost is consider low and consumers tend to be flexible when choosing an airline
companies due to the main focus being on flying times and airport locations.
Bargaining Power of Suppliers
Airbus and Boeing are the two major airline manufacturers. Althouth the parts of
the aircrafts are standardized switch suppliers is difficult to the contract
agrrements with suppliers due to the price of airplanes. The bargaining power of
suppliers is low as manufacturers rely solely on airline firms to purchase their
products.
Threat of new Entrants
An entry of new investments is considered as the airplane industry as highly
profitable. Additional new entrants also include tightly regulated authorities, the
difficulty to break brand loyalty for the opponents, and congestion within in major
areas.
Threat of Substitute Products
The threat of substitute products are by road, rail, and marine travels.
Competitive Rivalry within an industry
There is a slower growth rate which set the aspect of competition fairly high.
Fixed costs are also high with lower marginal costs.
This is not an attractive industry as attractive industries have low supplier power, low
buyer poer, high entry barriers, low threat of substitutes, and low rivalry. This industry
does not meet those qualifications which makes it an unattractive industry.
Individual Problem 15-5. Renegotiating Employment Contracts
a). Diagram the simulateneous move game?
Does the ability to move first give the employer advantage? If so, how? As the
employee, is there anything you could do to realize a higher payoff?
Yes, the employer receives an advantage because if the employer offers the
lower salary and the employee accepts the highest profit received for employer
and employee is 100 and 75, repectively. Whereas, if the most likely outcome
wasn’t the employer having the advantage of offering the lower salary, a higher
salary for an accepted employee will give the employer and employee, 75 and
100, respectively. As the nash equilibrium is created through the profit of the
student depending upon the offer of the employer, student could take the
advantage of setting the higher salary offer first.
Labor
LawyerNo Lawyer
ManagementLawyer($300,000, $300,000)($550,000, $250,000)
No Lawyer($250,000, $550,000)($500,000, $500,000)
No lawyer for both 1 Million /2 = 500,000
Lawyer for both 500,000- 200,000 = 300,000
Lawyer for one = (3/4) * 1 million-200,000 = 550,000
No Lawyer for one = (1/4) *1 million = 250,000
b). What is the Nash Equilibrium of the game?
In the Nash Equilibrium, both would hire the lawyer and the nash equilibrium payoff would be
($300,000, $300,000) because hiring the lawyer for both is the dominant strategy.
c). Would the sides want to ban lawyers?
Yes, they would want to ban the lawyers as they would receive a higher profit of $500,000 with
“No lawyer” than $300,000 with a lawyer.
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