Page 719 - Krugmans Economics for AP Text Book_Neat

Section 12 Summary

b.Now suppose the two airlines play this game twice. And each will earn a profit of $2 million. If they both advertise, each
suppose each airline can play one of two strategies: it can will earn a profit of $1.5 million. If one firm advertises and the
play either “always charge the low price” or “tit for tat”— other does not, the firm that advertises will earn a profit of
that is, start off charging the high price in the first period, $2.8 million and the other firm will earn $1 million.
and then in the second period do whatever the other airline a. Use a payoff matrix to depict this problem.
did in the previous period. Write down the payoffs to Un-
b.Suppose Philip Morris and R.J. Reynolds can write an en-
tied from the following four possibilities:
forceable contract about what they will do. What is the co-
i. Untied plays “always charge the low price” when Air “R”
operative solution to this game?
Us also plays “always charge the low price.”
ii. Untied plays “always charge the low price” when Air “R” c. What is the Nash equilibrium without an enforceable con-
Us plays “tit for tat.” tract? Explain why this is the likely outcome.
iii. Untied plays “tit for tat” when Air “R” Us plays “always 10. Use the three conditions for monopolistic competition dis-
charge the low price.” cussed in this section to decide which of the following firms
iv. Untied plays “tit for tat” when Air “R” Us also plays “tit are likely to be operating as monopolistic competitors. If they
for tat.” are not monopolistically competitive firms, are they monopo-
8. Suppose that Coke and Pepsi are the only two producers of lists, oligopolists, or perfectly competitive firms?
cola drinks, making them duopolists. Both companies have a. a local band that plays for weddings, parties, and so on
zero marginal cost and a fixed cost of $100,000.
b.Minute Maid, a producer of individual-serving juice boxes
a. Assume first that consumers regard Coke and Pepsi as per-
c. your local dry cleaner
fect substitutes. Currently both are sold for $0.20 per can,
d.a farmer who produces soybeans
and at that price each company sells 4 million cans per day.
i. How large is Pepsi’s profit? 11. You are thinking of setting up a coffee shop. The market struc-
ii. If Pepsi were to raise its price to $0.30 cents per can, and ture for coffee shops is monopolistic competition. There are
Coke did not respond, what would happen to Pepsi’s three Starbucks shops, and two other coffee shops very much
profit? like Starbucks, in your town already. In order for you to have
b.Now suppose that each company advertises to differentiate some degree of market power, you may want to differentiate
its product from the other company’s. As a result of adver- your coffee shop. Thinking about the three different ways in
tising, Pepsi realizes that if it raises or lowers its price, it will which products can be differentiated, explain how you would
sell less or more of its product, as shown by the demand decide whether you should copy Starbucks or whether you
schedule in the accompanying table. should sell coffee in a completely different way.
12. The restaurant business in town is a monopolistically compet-
Price of Pepsi Quantity of Pepsi demanded itive industry in long-run equilibrium. One restaurant owner
(per can) (millions of cans) asks for your advice. She tells you that, each night, not all ta-
bles in her restaurant are full. She also tells you that if she low-
$0.10 5
ered the prices on her menu, she would attract more customers
0.20 4 and that doing so would lower her average total cost. Should
0.30 3 she lower her prices? Draw a diagram showing the demand
curve, marginal revenue curve, marginal cost curve, and aver-
0.40 2
age total cost curve for this restaurant to explain your advice.
0.50 1 Show in your diagram what would happen to the restaurant
owner’s profit if she were to lower the price so that she sells the
minimum-cost output.
If Pepsi now were to raise its price to $0.30 per can, what
would happen to its profit? 13. The market structure of the local gas station industry is mo-
nopolistic competition. Suppose that currently each gas sta-
c. Comparing your answer to part a(i) and to part b, what is
tion incurs a loss. Draw a diagram for a typical gas station to
the maximum amount Pepsi would be willing to spend on
show this short-run situation. Then, in a separate diagram,
advertising?
show what will happen to the typical gas station in the long
9. Philip Morris and R.J. Reynolds spend huge sums of money run. Explain your reasoning.
each year to advertise their tobacco products in an attempt to
14. The local hairdresser industry has the market structure of mo-
steal customers from each other. Suppose each year Philip
nopolistic competition. Your hairdresser boasts that he is mak-
Morris and R.J. Reynolds have to decide whether or not they
ing a profit and that if he continues to do so, he will be able to
want to spend money on advertising. If neither firm advertises,

Summary 677