Page 368 - The Principle of Economics

374 PART FIVE FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
6. Suppose that you and a classmate are assigned a project on which you will receive one combined grade. You each want to receive a good grade, but you also want to do as little work as possible. The decision box and payoffs are as follows:
9. Farmer Jones and Farmer Smith graze their cattle on the same field. If there are 20 cows grazing in the
field, each cow produces $4,000 of milk over its
lifetime. If there are more cows in the field, then each cow can eat less grass, and its milk production falls. With 30 cows on the field, each produces $3,000 of milk; with 40 cows, each produces $2,000 of milk. Cows cost $1,000 apiece.
a. Assume that Farmer Jones and Farmer Smith can each purchase either 10 or 20 cows, but that neither knows how many the other is buying when she makes her purchase. Calculate the payoffs of each outcome.
b. What is the likely outcome of this game? What would be the best outcome? Explain.
c. There used to be more common fields than there are today. Why? (For more discussion of this topic, reread Chapter 11.)
10. Little Kona is a small coffee company that is considering entering a market dominated by Big Brew. Each company’s profit depends on whether Little Kona enters and whether Big Brew sets a high price or a low price:
Your Decision
You get A grade, no fun
Classmate gets A grade, no fun
You get B grade, fun
Classmate gets B grade, no fun
Classmate's Decision
You get B grade, no fun
Classmate gets B grade, fun
You get D grade, fun
Classmate gets D grade, fun
Work
Shirk
Work Shirk
Assume that having fun is your normal state, but having no fun is as unpleasant as receiving a grade that is two letters lower.
a. Write out the decision box that combines the letter
grade and the amount of fun you have into a single
payoff for each outcome.
b. If neither you nor your classmate knows how much
work the other person is doing, what is the likely outcome? Does it matter whether you are likely to work with this person again? Explain your answer.
7. The chapter states that the ban on cigarette advertising on television in 1971 increased the profits of cigarette companies. Could the ban still be good public policy? Explain your answer.
8. A case study in the chapter describes a phone conversation between the presidents of American Airlines and Braniff Airways. Let’s analyze the game between the two companies. Suppose that each company can charge either a high price for tickets or a low price. If one company charges $100, it earns low profits if the other company charges $100 also, and high profits if the other company charges $200. On the other hand, if the company charges $200, it earns very low profits if the other company charges $100, and medium profits if the other company charges $200 also.
a. Draw the decision box for this game.
b. What is the Nash equilibrium in this game?
Explain.
c. Is there an outcome that would be better than
the Nash equilibrium for both airlines? How could it be achieved? Who would lose if it were achieved?
Big Brew threatens Little Kona by saying, “If you enter, we’re going to set a low price, so you had better stay out.” Do you think Little Kona should believe the threat? Why or why not? What do you think Little Kona should do?
11. Jeff and Steve are playing tennis. Every point comes down to whether Steve guesses correctly whether Jeff will hit the ball to Steve’s left or right. The outcomes are:
Little Kona
Enter
Don't Enter
Kona makes $2 million
High Price
Low Price
Brew makes $3 million
Big Brew
Kona loses $1 million
Brew makes $1 million
Kona makes zero
Brew makes $7 million
Kona makes zero
Brew makes $2 million