Page 1

There may be some duplication. Sorry!

1. Two large diversified consumer products firms are about to enter the
market for a new pain reliever. The two firms are very similar in terms
of their costs, strategic approach, and market outlook. Moreover, the
firms have very similar individual demand curves so that each firm
expects to sell one-half of the total market output at any given price.
The market demand curve for the pain reliever is given as:
! "#$$ - %$$&.
'oth firms have constant long-run average costs of (".$$ per bottle.
&atent protection insures that the two firms will operate as a duopoly
for the foreseeable future. &rice and )uantities are per bottle. *f the
firms act as +ournot duopolists, solve for the firm and market outputs
and e)uilibrium prices.
". ,ambert--ogers +ompany is a manufacturer of petro-chemical products. The
firm.s research efforts have resulted in the development of a new auto
fuel in/ector cleaner that is considerably more effective than other
products on the market. 0nother firm, 1.2. 3)uires +ompany,
independently developed a very similar product that is as effective as
the ,ambert--ogers formula. To avoid a lengthy court battle over
conflicting patent claims, the two firms have decided to cross-license
each other.s patents and proceed with production. *t is unlikely that
other petrochemical companies will be able to duplicate the product,
making the market a duopoly for the foreseeable future. ,ambert--ogers
estimates the demand curve given below for the new cleaner. Marginal
cost is estimated to be a constant (" per bottle.
! 4$$,$$$ - "5,$$$&.
where & ! dollars per bottle and ! monthly sales in bottles.
a. ,ambert--ogers and 1.2. 3)uires have very similar operating
strategies. +onse)uently, the management of ,ambert--ogers believes
that the +ournot model is appropriate for analy6ing the market,
provided that both firms enter at the same time. +alculate ,ambert-
-ogers. profit-maximi6ing output and price according to this model.
b. ,ambert--ogers. productive capacity and technical expertise could
allow them to enter the market several months before 3)uires.
+hoose an appropriate model and analy6e the impact of ,ambert
-ogers being first into the market. 3hould ,ambert--ogers hurry to
enter first7
Page 2
4. 8niversity 'ookstore competes with +ampus 'ookstore in the textbook
market. 3ince 8niversity 'ookstore is on campus, they have 9first-move9
advantage. The bookstores compete by setting price. The demand function
for 8niversity 'ookstore is q
8
! 1",$$$ - :$P
8
; #$P
+
. The demand
function for +ampus 'ookstore is q
+
! 1",$$$ - :$P
+
; #$P
8
. +ampus
'ookstore.s marginal revenue function is: MR
+
<P
+
,P
8
= ! 1",$$$ - 1#$P
+
;
#$P
8
. +ampus 'ookstore.s marginal cost is: MC
+
<P
+
,P
8
=!-1,#$$. >etermine
+ampus 'ookstore.s price reaction function. 8niversity 'ookstore takes
+ampus 'ookstore.s behavior into account in determining it.s optimal
pricing behavior. 8niversity 'ookstore.s marginal revenue function is:
MR
8
<P
8
,P
+
= ! 1?,1$$ - 115P
8
. 8niversity 'ookstore.s marginal cost
function is: MC
8
<P
8
= ! -1,15$. >etermine 8niversity 'ookstore.s optimal
price. @hat is +ampus 'ookstore.s optimal price7 1iven that the cost to
both bookstores is ("$ per book and demand is symmetric, why does
8niversity 'ookstore charge a different price7 @hich bookstore makes a
larger profit7
%. 'uy--ight is a chain of grocery stores operating in small cities
throughout the southwestern 8nited 3tates. 'uy--ight.s ma/or competition
comes from another chain, 0cme Aood 3tores. 'oth firms are currently
contemplating their advertising strategy for the region. The possible
outcomes are illustrated by the payoff matrix below.
0cme Aoods

*ncrease >on.t *ncrease
0dvertising 0dvertising

'uy-right *ncrease
0dvertising "$, 15 45, -5
>on.t *ncrease
0dvertising ", 4$ "5, "5

Bntries in the payoff matrix are profits. 'uy--ight.s profit is before
the comma, 0cme.s is after the comma.
a. >escribe what is meant by a dominant strategy.
b. 1iven the payoff matrix above, does each firm have a dominant
strategy7
c. 8nder what circumstances would there be no dominant strategy for
one or both firms7
Page 3
5. Two firms at the 3t. ,ouis airport have franchises to carry passengers
to and from hotels in downtown 3t. ,ouis. These two firms, Metro ,imo
and 8rban ,imo, operate nine passenger vans. These duopolists cannot
compete with price, but they can compete through advertising. Their
payoff matrix is below:
8nited ,imo

*ncrease >on.t *ncrease

0dvertising 0dvertising
Metro ,imo

*ncrease
0dvertising "5, 15 4$, $
>on.t *ncrease
0dvertising 15, "$ %$, 5

a. >oes each firm have a dominant strategy7 *f so, explain and what
that strategy is.
b. @hat is the Cash e)uilibrium7 Bxplain where the Cash e)uilibrium
occurs in the payoff matrix.
#. +onsider two firms, D and E, that produce super computers. Bach can
produce the next generation super computer for the military <M= or for
civilian research <+=. 2owever, only one can successfully produce for
both markets simultaneously. 0lso, if one produces M, the other might
not be able to successfully produce M, because of the limited market.
The following payoff matrix illustrates the problem.
Airm E

M +

Airm D M ", 1 ", "
+ 1, 1 4, "

a. Aind the Cash e)uilibrium, and explain why it is a Cash
e)uilibrium.
b. *f Airm D were unsure that the management of Airm E were
rational, what would Airm D choose to do if it followed a
maximin strategy7 @hat would both firms do if they both followed
a maximin strategy7
Page 1
1. 'egin by solving for &.
! "#$$ - %$$&
- "#$$ ! -%$$&
& ! #.5 - $.$$"5
>enote the two firms 0 and ' and solve for reaction functions.
T-
0
! &
0

0
T-
0
! <#.5 - $.$$"5=
0
T-
0
! #.5
0
- $.$$"5F<
0
;
'
=
0
G
T-
0
! #.5
0
- $.$$"50" - $.$$"5
0

'
M-
0
! #.5 - $.$$5
0
- $.$$"5
'
3et M-
0
! M+
#.5 - $.$$5
0
- $.$$"5
'
! "
- $.$$5
0
! %.5 ; $.$$"5
'

0
! H$$ - $.5
'
Ine can verify that:

'
! H$$ - $.5
0
3ubstitute expression for
'
into
0

0
! H$$ - $.5<H$$ - $.5
0
=

0
! H$$ - %5$ ; $."5
0

0
- $."5
0
! %5$

0
<1 - $."5= ! %5$
%5$

0
! ! #$$
$.?5
3ubstitute expression for
0
into
'

'
! H$$ - $.5<H$$ - $.5
'
=
Page 2

'
! H$$ - %5$ ; $."5
'

'
- $."5
'
! %5$

'
<1 - $."5= ! %5$
%5$

'
! ! #$$
$.?5

T
!
0
;
'

T
! #$$ ; #$$ ! 1"$$
& ! #.5 - $.$$"5<1"$$=
& ! (4.5 per bottle
Page 3
". >enote ,ambert--ogers price and )uantity as &
,
,
,
and 3)uires as
&
3
,
3
.
>emand function is given as:
! 4$$,$$$ - "5,$$$&
3olve for &:
- 4$$,$$$ ! -"5,$$$&
& ! 1" - $.$$$$%
Iutcome under +ournot model:
a. T-
,
! &
,

,
T-
,
! <1" - $.$$$$%=
,
!
,
;
3
T-
,
! F1" - $.$$$$%<
,
;
3
=G
,


"
T-
,
! 1"
,
- $.$$$$%
,
- $.$$$$%
,

3
M-
,
! 1" - $.$$$$:
,
- $.$$$$%
3
3et M-
,
! M+
1" - $.$$$$:
,
- $.$$$$%
3
! "
-$.$$$$:
,
- $.$$$$%
3
! -1$

,
! 1"5,$$$ - $.5
3
3o,
3
! 1"5,$$$ - $.5
,
3ubstitute for
3
:

,
! #",5$$ ; $."5
,
#",5$$
! ! ! :4,444
$.?5
!
,
;
3
! :4,444 ; :4,444 ! 1##,###
Page 4
& ! 1" - .$$$$%<1##,###=
& ! 1" - #.#? ! (5.44
& ! (5.44 per bottle
1##,### bottles sold per month
b. The 3tackelberg model is appropriate when one firm enters first.
,ambert--ogers determines their output, which 3)uires then takes
as given. ,ambert.s total revenue function is given as:

"
T-
,
! 1"
,
- $.$$$$%
,
- $.$$$$%
,

3
3)uires reaction function
3
! 1"5,$$$ - $.5
,
can be substituted
into T-
,
, since 3)uires will take ,ambert.s output as given.

"
T-
,
! 1"
,
- $.$$$$%
,
- $.$$$$%
,
<1"5,$$$ - .5
,
=

"

"
T-
,
! 1"
,
- $.$$$$%
,
- 5
,
; $.$$$$"
,

"
T-
,
! ?
,
- $.$$$$"
,
M-
,
! ? - $.$$$$%
,
3et M-
,
! M+
? - $.$$$$%
,
! "
-$.$$$$%
,
! -5

,
! 1"5,$$$
To find
3
substitute
,
into 3 reaction function

3
! 1"5,$$$ - $.5
,

3
! 1"5,$$$ - $.5<1"5,$$$=

3
! #",5$$
!
,
;
3
! 1"5,$$$ ; #",5$$
Page 5
! 1:?,5$$
& ! 1" - $.$$$%<1:?,5$$=
& ! 1" - ?.5 ! (%.5$
,ambert--ogers gets a much larger share of the market by entering
first. They should advance their schedule in order to enter first.
:.#: - ?.4%
, ! ! $.15
:.#:
4. +ampus 'ookstore.s price reaction function is determined by setting
MR
+
<P
+
,P
8
= ! MC
+
<P
+
,P
8
= and solving for the firm.s own price as a
function of 8niversity 'ookstore.s price. This implies 1",$$$ - 1#$P
+
4
; #$P
8
! -1,#$$ P
+
! :5 ; P
8
. 8niversity 'ookstore.s optimal price
:
is determined by setting MR
-
<P
-
= ! MC
-
<P
-
= and solving for the firm.s
own price. This implies 1?,$$$ - 115P
8
! -1,15$ P
8
! 15:.#H. @e can
plug 8niversity 'ookstore.s price into +ampus 'ookstore.s reaction
function to determine +ampus 'ookstore.s profit maximi6ing price
4
choice. This is P
+
! :5 ; <15:.#H= ! 1%%.5$. 8niversity 'ookstore
:
sells ?,H?%.: books while +ampus 'ookstore sells H,H#1.% books.
8niversity 'ookstore.s profits are (1,1$#,$"5 and +ampus 'ookstore.s
profits are (1,"%$,1H%.4. +ampus 'ookstore makes a larger profit even
though 8niversity 'ookstore has 9first-move9 advantage. @ithout
9first-move9 advantage, both bookstores would charge (14# per book
and earn profits of (1,$?#,%:$. The 9first-move9 ability allows
8niversity 'ookstore to increase profits by over ".?J. *n doing so,
+ampus 'ookstore.s profits rise by over 15."J.
%. a. 0 dominant strategy is one that is optimal regardless of the rival
strategy.
b. Aor both firms, the dominant strategy is to increase advertising.
*f 0cme increases advertising, 'uy--ight earns "$ by increasing, "
by not increasing.
&rofit is higher for 'uy--ight by increasing, regardless of 0cme.s
choice.
The same can be shown to be true for 0cme.
c. Bither or both firms would not have a dominant strategy if their
best choice depended on the choice of their rival.
Page 6
5. a. Airm 0 has no dominant strategy. *f ' advertises, then 0 does
best by advertisingK but if ' does not advertise, then 0 should
not advertise. Airm ' has a dominant strategy, and it should
advertise.
b. The Cash e)uilibrium is for both firms to advertise. Bach does
best, "5 and 15, respectively, by advertising, given what the
other firm does.
#. a. The Cash e)uilibrium occurs at the bottom right on the +,+
position. *n this position, each firm does its best given what
the other firm does.
b. Airm D would find the maximum of the minimum payoffs. *f Airm D
chose M, the minimum payoff for D would be ". *f Airm D chose +,
then the minimum payoff for D would be 1. Thus, the maximum
would be ". Airm D should choose M. *f both firms followed a
maximin strategy, then the top right corner "," would by the
outcome.