Running Head: QUESTIONS FOR CRITICAL THINKING 5
Questions for Critical Thinking #5
Adrian Riley
Liberty University
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QCT 5
Questions for Critical Thinking #5
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In what way does OPEC resemble a cartel? How successful is it?
OPEC is known as a centralized cartel; or a formal agreement among oligopolistic
producers of a product to set a monopoly price, allocate output among its members, and
determine how profits are to be shared [Sal15]. OPEC is the largest oil supplier in the world and
an organization of several countries that meet to control the output and price of oil. In addition,
the countries come to an agreement about how profits are shared. OPEC has been reasonably
successful for quite some time. The organization has control over one of the most popular natural
resources, oil. OPEC has not seen great return because of the organization’s unwillingness to
drop its prices of oil in a market that is declining.
What is the difference between limit pricing and contestable markets?
Limit pricing is where existing firms charge a price so low that is discourages entry into a
particular market. Existing firms are sacrificing short term returns for long term profits [Sal15].
A contestable market allows for multiple competitors to enter the market, but there are just a few
suppliers. A market becomes contestable when entry is absolutely free and exit is costless. The
difference between limit pricing and a contestable market is the fact that limit pricing prevents
competition and entry into the market; while a contestable market encourages and allow free
entry and exit into the market [Sal15].
Examine the U.S. passenger airline industry using the Five Forces. Is this an attractive
industry? Why or why not?
QCT 5
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,
respectively; (b) one firm with a 50 percent share of the market and 10 other equal sized
firms; 10 equal sized firms.
a.H = 702 + 202 + 102 = 4900 + 400 + 100 = 5,400
b.H = 502 + 52 + 52 + 52 + 52 + 52 + 52 + 52 + 52 + 52 + 52 = 2,750
c.H = 102 + 102 + 102 + 102 + 102 + 102 + 102 + 102 + 102 + 102 = 1,000
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Since underprice leadership by the dominant firm, the firms in the industry following the
leader behave as perfect competitors or price takers by always producing where the price
set by the leader equals the sum of their marginal cost curves, the following break even in
the long run. True or false? Explain.
This statement is true. Breaking even means the price is equal to the average cost. The
dominant firm may be making profits, but there is no evidence that shows the following firms are
making profits. In addition, the dominant firm make have the privilege of having lower average
costs. But, if there are no barriers to entry and exit is costless, then competitors are expected to
be in the market for long run profits. But, if competition is not perfect and competitors are
making profits, they will not be sustainable for the long run.
4. Threat from Substitutes
3.Supplier Power
The power of suppliers is very high in the airline industry. There are three resources that are
necessary for airlines: fuel, airplanes, and labor. All three of the necessities are subjected to the
external factors. Fuel is subjected to the constant variability of the global oil industry. Labor is
subject to the power and regulation of labor unions. Finally, the aircrafts are supplied by only a
few suppliers making the supplier power high.
QCT 54
1.Entry and Exit Barriers
A huge investment is need to enter the market and exit is far from costless. In addition, countries
and organization may subject airlines to entry and exit regulations. Therefore, there are high
barriers to entry.
2.Buyer Power
Technology has allowed consumers to order tickets using online ticketing and distribution
systems. Consumers enjoy the freedom form agents and other suppliers for their ticketing needs.
This has allowed low cost carriers and started pricing wars among airlines, all have benefited the
consumer. There is moderately high power that belongs to the buyers.
5.Rivalry Between Existing Firms
The airline industry is extremely competitive due to the high barriers of entry and heavy
regulation of the airline industry.
How did the 1971 law that banned cigarette advertising on television solve the prisoners’
dilemma for cigarette producers?
The ban gave cigarette companies the opportunity to examine ways to bring in profits.
During the process, cigarette companies were able to reduce costs of advertising because of
the ban in 1971.
Based on the Five Forces, the airline industry is not an attractive industry mainly because of the
high supplier power, high buyer power, and immense competition.
QCT 55
There is little to no threat of substitutions in the airline industry. There is no alternative to flying
that matches the efficiency of time and convenience.
Do the duopolists in a Cournot equilibrium face a prisoners’ dilemma? Explain.
The duopolists in a Cournot equilibrium faces a prisoner’s dilemma. In a Cournot
equilibrium, each player’s strategy is optimal. Each player works separately to optimize output
and to select prices of goods. Due to the lack of communication and competitor knowledge, each
player may be harming the firm. Therefore, it may be worthwhile for the two players to work
together.
Given the following payoff matrix, (a) indicate the best strategy for each firm. (b) Why is
the entry deterrent threat by frim B? (c) What could firm A do to make its threat credible
without building excess building excess capacity?
a.The best strategy for both firms is to charge the low price option.
b.The entry deterrent threat is the fear of decreasing payoff. If Firm B does not lower
the price, than there will be negative returns.
c.Firm A should keep a low price strategy.
Explain why the payoff matrix in Problem 1 indicates that firms A and B face the
prisoners’ dilemma.
The prisoner's dilemma in the payoff matrix shows that if both firms charge high prices,
they could both make high profits. However, if Firm A keep prices high while Firm B keeps
prices low, Firm A would have a decrease in profit. Furthermore, if both firms keep prices low,
then both firms suffer losses. Ultimately, a prisoner's dilemma is present in the payoff matrix.
QCT 56
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.
a.Firm A does not have a dominant strategy.
b.Firm B has a dominant strategy.
c.Firm A’s optimal strategy is to charge high price. Firm B’s optimal strategy is to
charge a low price.
d.There is a NASH equilibrium for the low price for both Firm A & B.
QCT 57
The below figure 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? If so, how? As the employee, is there anything you could do to realize a higher
payoff?
The most likely outcome of this scenario is for the employer to give the low salary offer
and the employee accepts it.
The employer has an advantage by being able to make the first offer. This allows the employer to
force movement towards a lower salary. In addition, the employee is usually in need of the job,
therefore, the employer has a higher advantage over the employee.
The potential employee should communicate clearly that if the salary offer is too low, than the
potential employee can negotiate salary or look for employment else where.
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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 $ 200,000) who is effective at preparing the proposal in the best 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. (b) What is the Nash Equilibrium of the game? (c) Would the
sides want to ban lawyers?
Managem ent
No LawyerLawyer
LaborNo Lawyer$500,000, $500,000$250,000, $550,00
QCT 5
Lawyer $550,000, $250,000 $300,000. $300,000
This is a prisoners’ dilemma, both labor and management should hire a lawyer. Conversely, if
both sides decide not to hire a lawyer, each side would receive beneficial returns in the long run.
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Bibliography
Salvatore, D. (2015). Managerial Economics in a Global Economy (8th Edition ed.). New York,
New York, United States of America: Oxford University Press.
QCT 5 9
