ECON 705 Assignment 6 - The following data for your firm

ECON 705 Assignment 6

SECTION OVERVIEW: Chapter 12 utilizes many of the tools developed in the previous chapter but applies them to markets where a firm or firms exercise some degree of market power. Market power allows firms to free themselves from the competitive price-taking situation so that they face downward-sloping demand curves. Chapter 13 provides an introduction to the strategic decision-making processes used by oligopoly firms, where pricing and output decisions between firms is interdependent. It provides a rough sketch of the major concepts in game theory (prisoners’ dilemma, Nash EQ, game trees, etc.).

LEARNING GOALS: Upon completing this section, we will understand how perfectly competitive firms differ from monopolies and from monopolistically competitive firms. We will be able to determine profit-maximization in both situations, and how entry and exit in the long run affects profitability. We will also become familiar with various tools of measuring market power. We will have a few tools with which to analyze strategic decisions, and how decisions made by one firm affect decisions made by others (competitors or otherwise).

1. You are given the following data for your firm, which sells high-capacity video MP3 players.

Q P TC

0 $440 $100

2 $420 $468

4 $400 $788

6 $380 $1,084

8 $360 $1,380

10 $340 $1,700

12 $320 $2,068

14 $300 $2,508

16 $280 $3,044

18 $260 $3,700

20 $240 $4,500

a. Determine equations for P=f(Q), MR=f(Q), ATC=f(Q, Q2), AVC=f(Q, Q2), MC=f(Q, Q2). Recall that your marginal equations should be derivatives of your totals!

b. Determine the profit-maximizing price and quantity. (Since MC is in terms of Q2, solving with calculus and algebra can be messy. Your table should give an exact answer.)

c. How much total profit would your firm earn if you set P and Q according to part b?

d. Describe the competitiveness of the market by calculating the Lerner index.

2. Read the following two news stories about Starbucks: (http://www.cnbc.com/2013/11/18/it-won-but-small-coffee-company-hurt-by-starbucks-suit.html) and (http://abcnews.go.com/2020/GiveMeABreak/story?id=1390867). Why do you think Starbucks is willing to incur the expense of (litigiously) fighting against small coffee shops who stray uncomfortably close to Starbucks’ brand? What do these stories suggest about Starbucks’ market power in theory (e.g., just looking at market share) vs. in reality (e.g., looking at its actions in cases such as these)?

3. Political scientists usually conclude that voters dislike negative campaign ads, but we can use game theory to offer an explanation for why they continue to be used. While negative ads are (nauseatingly) commonplace in electoral competition, they are far less frequent in business competition; i.e., it is rare to see company A directly attacking the quality or character of competing company B to the extent that political candidate X attacks political candidate Y. (We might see a company talk about the insufficiencies of “the leading brand,” but the negativity is very tame compared to what happens during campaign season.) How might game theory also offer an explanation for this behavior?

4. The following is a payoff matrix showing profit in millions of dollars when two companies simultaneously decide on various advertising budgets ($1 million, $2 million, or $3 million):

Pizza Hut

$1 mill $2 mill $3 mill

$1 mill $30 / $30 20 / 35 35 / 40

Papa Johns $2 mill 40 / 50 25 / 40 45 / 45

$3 mill 35 / 45 30 / 35 40 / 55

a. In the first round of strategy elimination, which ad budget would the companies exclude?

b. After the first round of elimination, would either company make a second-round elimination?

c. What would be the likely outcome of this simultaneous advertising decision (i.e. what ad budget would each company end up choosing)?