ECON 111 – Problem Set 5: Oligopoly and Monopolistic Competition
Question 1: The figure below represents Tony’s Pizza Parlor, a firm in monopolistic competition.
a. What price will Tony charge in this market? What is the output Tony is producing?
b. At the profit maximizing level of output, what is Tony’s total revenue of production? Cost of production?
c. Shade the area that represents consumer surplus.
d. Shade the area that represents profits.
e. Is this a long-run equilibrium? Why or why not?
Question 2: Consider a small town that has two grocery stores from which residents can choose to buy a candy. The store owners each must make a decision to set a high candy price or a low candy price. The payoff table, showing profit per week, is provided below. The profit in each cell is shown as (Claudia, Julio).
a. Refer to the scenario above. Does Claudia’s Confections have a dominant strategy? If so what?
b. Refer to the scenario above. Does Julio’s Jellies have a dominant strategy? If so what?
c. Is there a Nash Equilibrium for this game? If so, what is it?
Question 3: Duff Beers and Three Broomsticks Butter Beers are beer companies that operate in a duopoly. The daily marginal cost of producing a bottle of beer is constant and equals $1.20 per bottle. Assume that neither firm had any start up costs, so marginal cost equals average total costs for each firm. Suppose Duff and Three Broomsticks form a cartel and the firms divide output and profits equally.
a. Indicate the profit-maximizing price and combined quantity of output if Duff and Three Broomsticks choose to work together on the graph above.
b. When they act as a single profit-maximizing cartel, each company will produce ___________ bottles and charge ____________ per bottle. Given this information, each firm earns a daily profit of ____________, so the total industry profit in the beer market is ___________.
c. Again, assume the two companies form a cartel and decide to work together. Both firms initially agree to produce half the quantity that maximizes total industry profit. Now, suppose that Duff decides to break the collusion and increase its output double its original units, while Three Broomsticks continues to produce the amount set under the collusive agreement.
Duff’s deviation from the collusive agreement causes the price of a bottle of beer to (increase/decrease) to ___________ per bottle. Duff’s profit is now ____________, while Three Broomstick’s profit is now ____________. Therefore, you conclude that total industry profit (increases/decreases) when Duff increases its output beyond the collusive quantity.
d. Suppose that the only barrier to entry protecting Duff and Three Broomsticks was a patent and it has expired, causing the market to be flooded with many competitors. The market would produce a total of _________ units. The profit for each firm would be __________. Outline the new consumer surplus in this situation.
Question 4: Opinion Piece
Please read the following on Blackboard:
• “America has an oligopoly problem”
• “15 Oligopoly advantages and disadvantages”
Do you think America has an oligopoly problem? It is true many industries are becoming oligopolistic but R&D, one of the benefits of an oligopoly, is the highest it has ever been. However formation of oligopolies can come at the cost of higher inequality. Do you think the U.S. should have stricter anti-trust laws or do you think the benefits of oligopolies outweigh the costs?
