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Review questions
1 An industry faces the demand curve:
Q 1 2 3 4 5 6 7 8 9 10
P 10 9 8 7 6 5 4 3 2 1
(a) Suppose it is a monopolist whose constant MC=3: what price and output are chosen?
(b) Now suppose there are two firms, each with MC=AC=3: what price and output maximize joint profits if they collude?
(c) Why might each firm be tempted to cheat if it can avoid retaliation by the other?
2 With the above industry demand curve, two firms, A and Z, begin with half the market each when charging the monopoly price. Z decides to cheat and believes A will stick to its old output level.
(a) Show the demand curve Z believes it faces.
(b) What price and output would Z then choose?
3 Vehicle repairers sometimes suggest that mechanics should be licensed so that repairs are done only by qualified people. Some economists argue that customers can always ask whether a mechanic was trained at a reputable institution without needing to see any licence.
(a) Evaluate the arguments for and against licensing car mechanics.
(b) Are the arguments the same for licensing doctors?
4 Think of five adverts on television. Is their function primarily informative or the erection of entry barriers to the industry?
5 A good-natured parent knows that children sometimes need to be punished but also knows that, when it comes to the crunch, the child will be let off with a warning. Can the parent undertake any pre-commitment to make the threat of punishment credible?
6 Common fallacies Why are these statements wrong?
(a) Competitive firms should get together to restrict output and drive up the price.
(b) Firms would not advertise unless they expected advertising to increase sales.
7 Harder question ‘Since a firm’s optimal behavior depends on how it believes that its rival(s) will react, there are as many output decisions, and hence equilibria, as there are guesses about what rivals will do.’ How do economists try to narrow down the assumptions that firms make about their rivals?
8 Harder question Many of the interesting games are games against the government. Think of a European airline, until recently state-owned, now private but losing money under the pressure of high oil prices and the growth of low-cost airlines. Believing that the government will bail it out if the worst comes to the worst, the airline has no incentive to take the tough measures today needed to make its business profitable. How can the government signal that it will not bail out the airline , forcing the airline to improve or go bust?
9 Essay question ‘Globalization, by increasing the size of the market, reduces market power of individual firms and the need to address strategic interactions.’ ‘Globalization increases the payoff to scooping the pool, making mergers more attractive and enhancing worries about market power.’ Are either of these views correct? Both of them?
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