Exam Notes

Field Cruiser vs. Nice Ride

Payoff Matrix Scenario

  • Two producers: Nice Ride and Field Cruiser.
  • Nice Ride: Improve Safety or Comfort.
  • Field Cruiser: Improve Reliability or Power.
  • Payoff matrix: (Nice Ride's profit, Field Cruiser's profit).
  • Firms act independently and simultaneously.
  • Complete information; no cooperation.
(a) Field Cruiser's Best Strategy (Nice Ride chooses Safety)
  • Determine Field Cruiser's most profitable strategy.
  • Compare payoffs for Reliability vs. Power when Nice Ride chooses Safety.
  • If Nice Ride chooses Safety:
    • Field Cruiser's payoff for Reliability: 28million28 million.
    • Field Cruiser's payoff for Power: 32million32 million.
  • Field Cruiser's most profitable strategy: Power.
(b) Nice Ride's Dominant Strategy
  • Determine if Nice Ride has a dominant strategy.
  • A dominant strategy is the best choice regardless of the other firm's action.
  • If Field Cruiser chooses Reliability:
    • Nice Ride's payoff for Safety: 10million10 million.
    • Nice Ride's payoff for Comfort: 30million30 million.
  • If Field Cruiser chooses Power:
    • Nice Ride's payoff for Safety: 28million28 million.
    • Nice Ride's payoff for Comfort: 40million40 million.
  • Nice Ride's dominant strategy: Comfort (always higher payoff).
(c) Nash Equilibrium: Safety/Power
  • Check if (Nice Ride: Safety, Field Cruiser: Power) is a Nash equilibrium.
  • Nash equilibrium: no firm can improve its profit by unilaterally changing its strategy.
  • Nice Ride chooses Safety:
    • Field Cruiser's best response: Power (32million32 million > 28million28 million).
  • Field Cruiser chooses Power:
    • Nice Ride's best response: Comfort (40million40 million > 28million28 million).
  • (Safety, Power) is not a Nash equilibrium.
(d) Merger to Maximize Combined Profits
  • Firms merge to maximize combined profits; produce both Nice Ride and Field Cruiser vehicles.
  • Values in the payoff matrix remain unchanged.
  • Calculate the combined profit for each strategy combination:
    • (Safety, Reliability): 10 million + $28 million = $38 million.
    • (Safety, Power): 28 million + $32 million = $60 million.
    • (Comfort, Reliability): 30 million + $40 million = $70 million.
    • (Comfort, Power): 40 million + $25 million = $65 million.
  • New firm's total profit: 70million70 million (Comfort, Reliability).
(e) Fuel Price Change
  • Fuel price increase reduces Power's profitability by 10million10 million for Field Cruiser.
  • New payoff matrix (Field Cruiser profits):
    • Reliability: Original value.
    • Power: Original value - 10million10 million.
  • New Payoff Matrix:
    • (Safety, Reliability): (10 million, $28 million)
    • (Safety, Power): (28 million, $32 million - $10 million = $22 million)
    • (Comfort, Reliability): (30 million, $40 million)
    • (Comfort, Power): (40 million, $25 million - $10 million = $15 million)
  • If Nice Ride chooses Safety:
    • Field Cruiser chooses Reliability (28 million > $22 million).
  • If Nice Ride chooses Comfort:
    • Field Cruiser chooses Reliability (40 million > $15 million).
  • Field Cruiser dominant strategy: Reliability.
  • If Field Cruiser chooses Reliability:
    • Nice Ride chooses Comfort (30 million > $10 million).
  • Nash equilibrium: (Comfort, Reliability).
  • Nice Ride's profit: 30million30 million.
  • Field Cruiser's profit: 40million40 million.

Good X Market

Perfect Competition and Externalities

  • Good X is sold in a perfectly competitive market.
  • Graph: Marginal Social Cost (MSC), Marginal Private Cost (MPC), Marginal Social Benefit (MSB), Marginal Private Benefit (MPB).
  • Quantity on x-axis, Price on y-axis.
(a) Market Equilibrium
  • Identify the market equilibrium price and quantity.
  • Market equilibrium: MPB = MPC.
  • From the graph:
    • Market equilibrium quantity: 500.
    • Market equilibrium price: 1515. (where MPB and MPC intersect)
(b) Deadweight Loss
  • Calculate the deadweight loss (DWL) at the market equilibrium.
  • DWL exists when there is a difference between MSC and MSB at the market quantity.
  • Socially optimal quantity occurs where MSC = MSB. From the graph, that quantity is 300.
  • DWL = 1/2 * (Market Quantity - Socially Optimal Quantity) * (MSC at Market Quantity - MSB at Market Quantity)
  • From the graph
    • MSC at 500 = 25
    • MSB at 500 = 15
  • DWL = 1/2 * (500 - 300) * (25 - 15) = 1/2 * 200 * 10 = $1000
(c) Government Intervention
(i) Tax or Subsidy
  • Objective: Eliminate the deadweight loss.
  • Corrective measure: Align private costs/benefits with social costs/benefits.
  • Since MPC < MSC, there is a positive externality, a per-unit tax on consumers will achieve the government's objective.
(ii) Dollar Value
  • Determine the value of the per-unit tax.
  • Tax should equal the difference between MSC and MPC at the socially optimal quantity.
  • Optimal quantity: 300.
  • From the graph:
    • MSC at 300 = 20
    • MPC at 300 = 10
  • Per-unit tax = 20 - 10 = $10
(d) Price Ceiling
  • Government imposes a price ceiling of 1010.
  • Will the price ceiling achieve the socially optimal quantity?
  • Socially optimal quantity: 300.
  • At a price of 1010, quantity demanded is greater than 300, and quantity supplied would be less than 300 based on the graph.
  • The price ceiling is below the market equilibrium price.
  • The price ceiling will not achieve the socially optimal quantity because the maximum quantity exchanged in the market would be less than 300.

Soja Farm - Soybeans

Perfect Competition in the Long Run

  • Soja Farm: Typical profit-maximizing firm.
  • Soybean market: Constant-cost, perfectly competitive in long-run equilibrium.
  • Market equilibrium price: 14perbushel14 per bushel.
(a) Side-by-Side Graphs
(i) Market Equilibrium
  • Market graph:
    • Equilibrium price: 1414.
    • Equilibrium quantity: QM.
(ii) Soja Farm
  • Firm graph:
    • Profit-maximizing price: PE = 1414.
    • Profit-maximizing quantity: QF.
    • Marginal Cost (MC) intersects Average Total Cost (ATC) at its minimum and is equal to the market price.
(iii) Average Total Cost
  • Soja Farm's ATC curve consistent with long-run equilibrium:
    • ATC is tangent to the market price (PE) at the quantity produced by the firm (QF).
    • ATC is at its minimum at QF
(b) Price Increase by Soja Farm
  • Soja Farm increases its price to 15perbushel15 per bushel.
  • Will total revenue increase, remain the same, or decrease?
  • Perfectly competitive market: firms are price takers.
  • If Soja Farm increases its price, it will sell zero soybeans.
  • Total revenue will decrease to zero.
(c) Increase in Tofu Popularity
(i) Market Effect
  • Tofu becomes more popular; soybeans are an input for tofu.
  • Demand for soybeans increases.
  • Market graph:
    • New equilibrium price: P₂ > 1414.
    • New equilibrium quantity: Q₂ > QM.
(ii) Soja Farm Effect
  • Firm graph:
    • New profit-maximizing quantity: Q > QF.
  • The firm will increase its output until MC = new higher market Price (P₂)
(d) Number of Firms in the Long Run
  • Given the increase in popularity of tofu, what happens to the number of firms in the soybean market in the long run?
  • Increased demand for soybeans increases the market price and firm profits in the short run.
  • In the long run, new firms will enter the market to take advantage of the higher profits.
  • Entry of new firms will shift the market supply curve to the right, decreasing market price.
  • The entry of firms continues until economic profits are zero.
  • The number of firms in the soybean market will increase.
(e) Elasticity
(i) Demand Elasticity of Quinoa
  • 25% increase in the price of quinoa causes a 5% decrease in the quantity demanded of quinoa.
  • Price elasticity of demand (PED) = % change in quantity / % change in price.
  • PED=−5PED = -5% / 25% = -0.2
  • |PED| = 0.2 < 1.
  • Demand for quinoa is inelastic.
(ii) Cross-Price Elasticity
  • 25% increase in the price of quinoa causes a 10% increase in the quantity demanded for tofu.
  • Cross-price elasticity of demand (CPED) = % change in quantity of tofu / % change in price of quinoa.
  • CPED=10CPED = 10% / 25% = 0.4