Running head: CRITICAL THINKING 5
Critical Thinking 5
Ben Yellets
Liberty University
Global Economic Environment
BUSI 620
Dr. Duda
April 14, 2014
1
DQ 10-8. In what way does OPEC resemble a cartel? How successful is it?
CRITICAL THINKING 52
DQ 10-2. (a) What are the advantages of the Herfindahl index over concentration
ratios in measuring the degree of concentration in an industry? (b) What is the
disadvantage of both?
OPEC resembles a centralized cartel. An agreement is set up between a few oligopolistic
firms to set a monopoly price and distribute profits accordingly. The main goal of OPEC is to
increase earnings based on outputs and adjust pricing as output changes.
OPEC was very successful in setting the price of oil prior to oil shock of 1973. The oil
shock have outsiders an opportunity to explore alternatives to oil resources. OPEC took a hit
because of this and where not as effective in setting the price.
The Iraq War changed this though as the demand for oil rose. This gave OPEC some
leverage that they had lost since the 1970s. OPEC has been able to impact the price on oil and
the overall industry, all though sometimes it has had greater impact than other times.
P 10-1. Find the Herfindahl index for an industry composed of (a) three firms – one
with 70 percent of the market, and the other two with 20 and 10 percent of the market,
The advantage of the Herfindahl index over the convention ratios is that it gives a more
accurate reading. The Herfindahl index uses information on all the firms in the industry whereas
the concentration ratios only using information on the market share of the larger firms in the
industry.
The disadvantage of both the Herfindahl index and the convention ratios is that
overestimate the market power of the largest firms in the industry.
a)70^2 + 20 ^2 + 10^2 = H
4900 + 400 + 100 = H
5400 = H
b)50^2 = 2500
5^2 = 25
25 * 10 = 250
2500 + 250 = 2750
H = 2750
c)10^2 = 100
100 * 10 = 1000
H = 1000
QA = (12 – QB)/2
QB = (12 – QA)/2
QA = 12 – ((12 – QA)/(2/2())
= (24 – (12 – QA))/(2/2)
= (24 – 12 + QA)/(2/2)
= 12 + QA/4
4QA = 12 + QA
CRITICAL THINKING 5
respectively; (b) one firm with a 50 percent share of the market and 10 other equal-sized
firms; (c) 10 equal-sized firms.
P 10-5. Starting with the reaction functions of duopolists A and B from Problem 4,
find the Cournot solution algebraically.
3
CRITICAL THINKING 5
QA = 4
QB = (12 – 4)/2
= 8/2 = 4
Q = QA + QB
= 4 + 4
Q = 8
Q = 12 – P
8 = 12 – P
P + 8 = 12
P = 4
DQ 11-12. How did the 1971 law that banned cigarette advertising on television
solve the prisoners’ dilemma for cigarette producers?
a)Tit-for-tat is strategy that involves doing to your competitor what they do to you. If
they cooperate with you, you cooperate with them. If they betray you, you betray
them. This strategy discourages noncooperation.
4
The purpose of this ban was to reduce the encouragement of smoking to the public. It did
accomplish this to a degree, but it also let cigarette producers turn greater profits. This solved
the prisoners’ dilemma for cigarette producers because they were able to eliminate TV
advertising expense. This reduced their overall costs and increased their profits, something they
were not able to do until this law became effective.
DQ 11-13. (a) What is the meaning of tit-for-tat in game theory? (b) What
conditions are usually required for tit-for-tat strategy to be the best strategy?
P 11-6. Explain why the payoff matrix in Problem 1 indicates that firms A and B
face the prisoners’ dilemma.
a)Firm A does not have a dominant strategy. Firm A will have a profit of 1 when both
firms offer low price. When Firm A offer high price, it will have a loss of 1 when
Firm B offers low price. If Firm B where to offer high price, Firm A would profit 3
when they offer low price and profit 4 when they offer high.
b)The dominate strategy for Firm B is to offer the low price
c)The optimal strategy for Firm B is to offer the lower price
d)The Nash equilibrium is when both set price low because they will both profit 1.
CRITICAL THINKING 55
b)There are five conditions that must exist for tit-for-tat to be the best strategy:
1)It requires a reasonably stable set of players
2)The number of players must be small
3)Each firm must be able to quickly detect cheating by the other firm
4)Demand and cost conditions must be relatively stable
5)We must assume the game is repeated indefinitely or at least for a long period of
time.
P 11-2. From the following payoff matrix, where the payoffs are the profits or losses
of the two firms, determine (a) whether firm A has a dominant strategy, (b) whether firm B
has a dominant strategy, (c) the optimal strategy for each firm, and (d) the Nash
equilibrium, if there is one.
Freob
P 11-10. Given the following payoff matrix, (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 its threat credible without building excess capacity?
IP 10-4. Examine the U.S. passenger airline industry using the Five Forces. Is this
an attractive industry? Why or why not?
a)Firm A’s best strategy would be to set price high and have a profit of 6 while Firm B
does not enter.
Firm B’s best strategy would to have both Firms set the price low because they would
profit 3 and Firm A would lose 1.
b)The threat by Firm A to lower price should not discourage firm B from entering the
market because it is not a credible threat.
c)To make this threat credible, Firm A would have to keep its price low that way any
other Firm trying to enter the market will take a loss. Firm A will not make as much
profit, but it will deter other Firms from entering the market.
CRITICAL THINKING 56
Both firms face the prisoners’ dilemma because the only way for each firm to earn a
profit of 2 would be for both firms to set their prices high. If one Firm sets there price high and
the other one low, there is big gap in profit.
The five forces are supplier power, buyer power, substitutes, entrants, and rivalry. First
let’s look at supplier power. The aircraft manufacturers do not have a lot of power because of the
IP 15-4. The following represents the potential outcomes of your first salary
negotiation after graduation: Assuming this is a sequential move game with the employer
moving first, indicate the most likely outcome. Does the ability to move first give the
employer an advantage? Is so, how? As the employee, is there anything you could do to
realize a higher payoff?
CRITICAL THINKING 57 intense competition. Unions could hold significant power. Fuel may
influence profitability. The
cost associated with airports could run high especially on international flights.
Buying power would be somewhat high because of the low cost to change.
Some substitutes for airline travel could be car or train. This would only be a substitute
for regional travel. New technology could also be considered a substitute. This could have an
effect on long distance travel.
The airline industry is relatively easy to enter.
The airline industry is very competitive because of high fixed costs.
Based on the information above the airline industry is not very attractive.
IP 15-5. Every year, management and labor renegotiate a new employment contract
by sending their proposals to an arbitrator who chooses the best proposal (effectively giving
one side or the other $1 million). Each side can choose to hire, or not hire, an expensive
labor lawyer (at a cost of $200,00) who is effective at preparing the proposal in the best
The most likely outcome would be employee accepts the low salary offer. The employer
does have a major advantage by making the first move. The employer can determine which
salary to offer. The only thing the employee can do to get the higher payoff would be to
communicate effectively with employer what they are willing to work for.
b.What is the Nash Equilibrium of the game?
The Nash Equilibrium would be if both hire lawyers or neither higher lawyers.
c.Would the sides want to ban lawyers?
Yes, both sides would want to pan lawyers because there is greater profit to be had if
no lawyers where hired.
CRITICAL THINKING 58 light. If neither hires lawyers or if both hire lawyers, each side can
expect to win about half
the time. If only one side hires a lawyer, it can expect to win three-quarters of the time.
a.Diagram this simultaneous move game.
If neither team hires a lawyer they are expected to win 50% of the time so the expected
payout would be $500,000. If they were to both hire lawyers, the chances would stay the same
but they would have to factor in the $200,000 lawyer fee making the profit only $300,000. If
one side hires a lawyer and the other does not, the side that hires the lawyer has a 75% chance of
winning. The side that hired the lawyer would expect a payoff of $550,000(75%(1 million) -
$200,000(lawyer fees)) and the side that did not hire the lawyer would expect a payoff of
$250,000.
Labor No Lawyer
Lawyer
Management
No LawyerLawyer
$ $500,000 , $500,000 $250,000 , $550,000
$550,000 , $250,000 $300,000, $300,000
