Industrial Organisation ECOS 3005
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School of Economics
Industrial Organisation ECOS 3005
November 2014
Part A (total 15 marks)
Instructions: Answer all 15 multiple choice questions on the answer sheet provided. Each multiple choice question is worth 1 mark.
1. Predatory pricing
(a) is the practice of setting a price below marginal costs.
(b) is an effective tactic for battling an equal adversary.
(c) is the practice of lowering price to prevent rival entry.
(d) is the practice of lowering price to encourage rival exit.
(e) None of the above.
2. Consider a perfectly competitive industry with market demand given by Q(P) = 800 - 10P, where Q is market quantity and P is the market price. There are 20 firms in the industry and each firm has the cost function C(q) = 400 + 6q + 
market supply curve?
(a) Q = p - 6
(b) Q = 2p - 12
(c) Q = 40p - 240
(d) Q = 2p +12
(e) None of the above.
3. A single firm produces Glonks. Glonks have market demand Q = 56 - P/2, where P is the market price. The firm’s costs are given by C(Q) = 12Q + 500. The monopolist’s profit-maximising quantity is
(a) Q = 10
(b) Q = 20
(c) Q = 25
(d) Q = 30
(e) None of the above.
4. Two firms produce Good A. Market demand is given by Q = 130 - P. Each firm has costs C(q) = 10q. Firm 1 has a capacity of K1 = 60 and Firm 2 has no capacity constraints. The firms compete by simultaneously choosing price in a single period.
(a) In the Nash equilibrium, both firms set a price of 10.
(b) There cannot be a Nash equilibrium with both firms setting a price of 10 because Firm 1 would have an incentive to raise price.
(c) There cannot be a Nash equilibrium with both firms setting a price of 10 because Firm 2 would have an incentive to raise price.
(d) There cannot be a Nash equilibrium with both firms setting a price of 10 because both Firms would have an incentive to raise price.
(e) In the Nash equilibrium, both firms gradually lower their price to 10 and then raise price.
5. Firm 1 is the only manufacturers of Product Z. Firms 2 and 3 are the only distributors of Product Z. The demand for Product Z is given by the relationship Q = 100 +A -P, where Q is the quantity of Product Z sold, P is its market price, and A is the combined level of advertising of Firm 2 and Firm 3.
The market for Product Z illustrates the problem of
(a) distributor free riding.
(b) manufacturer free riding.
(c) hold up.
(d) adverse selection.
(e) None of the above.
6. Consider the linear city model we studied in class. Firm 1 and Firm 2 are the two firms in the city. Consider each of the following statements in isolation. Which statement is correct?
(a) If transport costs are low, the firms will exploit this by raising price.
(b) Suppose city zoning laws force Firm 1 and Firm 2 to locate at either end of the city. Both firms will therefore set price close to marginal cost.
(c) Suppose a regulator sets the price for both firms at p
. Both firms will therefore choose to locate as far from each other as possible.
(d) If consumers are evenly spread throughout the city, firms are more likely to locate in the middle of the city.
(e) None of the above statements are correct.
7. Which of the following factors would make it more difficult to sustain a cartel in Industry X?
(a) There are no barriers to entry in Industry X.
(b) Firms in Industry X use different production techniques and have different cost functions.
(c) Strict anti-trust enforcement applies in the region in which Industry X operates.
(d) Firms in Industry X are impatient. That is, they have a low valuation for future profits.
(e) All of the above. That is, all of the above factors would make it harder to sustain a cartel.
8. Consider the Bertrand model we studied in class in which firms compete by simultaneously choos- ing prices. Which of the following statements is incorrect?
(a) In the Nash equilibrium, each firm chooses an optimal price given their rival’s price.
(b) If firms have equal marginal costs, then each firm earns no economic profitin equilibrium.
(c) Bertrand competition between three identical firms will lead to the same equilibrium price as Bertrand competition between 2 firms.
(d) Each firm plays a dominant strategy in equilibrium.
(e) None of the above. That is, all of the above statements are correct.
9. Which of the following statements best describes the hold-up problem?
(a) To build reputation, firms must beheld to their commitments.
(b) When firms interact, they often have asymmetric information.
(c) Being the first mover often provides a substantial advantage.
(d) Firms make strategic decisions designed to prevent the entry of competitors.
(e) Investments are sometimes of value only in interactions with a specificparty.
10. Consider the Stackelberg model of sequential quantity competition for a homogeneous product. In the subgame perfect Nash equilibrium to this game
(a) no firm has an incentive to change their output given the output of their competitor.
(b) no firm has an incentive to change their strategy given the strategy of their competitor.
(c) the follower has an advantage because they have the flexibility to choose their output after their competitor.
(d) All of the above.
(e) None of the above.
11. In the Bertrand model, firms set price equal to marginal cost in Nash equilibrium. The primary reason is that
(a) there are many firms in the market.
(b) because the products are identical, the lower price firm captures the entire market. (c) if the firms set the same price, they share the market equally.
(d) the firms produce differentiated products, so they have no incentive to raise prices. (e) price competition always leads to competitive pricing.
12. If firms have capacity constraints in the Bertrand model, setting price equal to marginal cost is not a Nash equilibrium. The primary reason is that
(a) if firms have capacity constraints, each firm will act like a monopolist.
(b) if the firms have capacity constraints, customers are forced to search for the cheapest product. (c) there is no incentive to undercut your rival because of capacity constraints.
(d) some customers will still buy their product if a firm has a higher price than their rival.
(e) None of the above.
13. Which of the following is not an example of a principal-agent relationship?
(a) The relationship between the shareholders and the managers of a company.
(b) The relationship between an employer and employees.
(c) The relationship between a financial planner and her customers.
(d) The relationship between a tenant and a landlord.
(e) All of the above are examples of a principal-agent relationship.
14. Which of the following statements is correct?
(a) Agency costs are always minimised by vertically integrating rather than transacting with another firm.
(b) Agency costs are always minimised by transacting with another firm rather than vertically integrating.
(c) Agency costs are not relevant for the firm’s vertical integration decision. (d) Monitoring solves the principal-agent problem.
(e) None of the above.
15. In the market for good Y , 7 firms produce an identical product. The firms have identical cost. Consumers know the distribution of prices, but they do not know the prices set by individual firms. It costs c > 0 for a consumer to learn a store’s price. The timing of play is as follows: First, firms compete by simultaneously setting price, then consumers visit a store and decide whether to buy, or to incur a search cost of c and visit another store.
(a) With 7 firms in the market, the only Nash equilibrium involves each firm setting price equal to marginal cost.
(b) If firms were to set price equal to marginal cost, each firm would have an incentive to relent to the monopoly price.
(c) If firms were to set price equal to marginal cost, each firm would have an incentive to raise price slightly.
(d) If firms were to set the monopoly price, each firm would have an incentive to undercut slightly.
(e) None of the above.
Part B (total 45 marks)
Instructions: Answer ANY THREE of the FOUR questions in the booklets provided. Each question is worth 15 marks. Please begin each question on a separate page. If you use diagrams to illustrate your arguments then explain and label them carefully. Wherever possible explain the intuition and logic underpinning your argument.
1. Two firms compete in a linear city of length 1 unit. Consumers are uniformly located along the
city. Consumer i’s utility derived from buying firm j’s product is given by
ui j = uj - t (li -xj)2 - pj ,
where j = 1, 2 indicate the two firms, t is the per unit cost of travelling along the city, li is the location of consumer i, xj is the location of firm j, and pj is the price of product j. Product one contains some intrinsically superior features and u1 = 22, while u2 = 20. Each consumer buys a single unit of the good. Firms compete with each other by simultaneously choosing prices. Each firm has constant marginal costs of c and no fixed costs.
(a) Assume that the two firms are located at each end of the city. That is, x1 = 0 and x2 = 1.
i. Calculate the demand for each firm in terms market prices and transport costs. [3 marks]
ii. Find the reaction function for each firm. [4 marks]
iii. Find the Nash equilibrium prices for each firm. [3 marks]
(b) Assume instead that both firms are located in the same spot with x1 = x2 = 0.4. Identify a Nash equilibrium in prices. Explain. [You may suppose that if consumers are indifferent they buy from Firm 1.] [5 marks]
2. The demand for good X is perfectly inelastic up to a price of $1.20. 1000 consumers are willing to buy exactly one unit each if the price is less than or equal to $1.20. Firms 1 and 2 are the only producers of good X. 700 of these consumers cannot tell the difference between the products of Firms 1 and 2 and will buy from the cheapest firm. (In the event that the prices of both firms are the same, half of these consumers will buy from each.) The remaining 300 consumers dislike Firm 1’s product and will only buy from Firm 2. Both firms have constant marginal costs of $0.20 and no fixed costs. They compete by simultaneously setting prices in a single period.
(a) Find the reaction function of Firm 1. [4 marks]
(b) Find the reaction function of Firm 2. [5 marks]
(c) Is there a Nash equilibrium in pure strategies to this game? Explain. [3 marks]
(d) Explain the role of consumer loyalty in your analysis. [3 marks]
3. Two firms produce an identical product and compete by simultaneously choosing price in a market with N consumers. Firms have no costs and the monopoly price is pm = 34. Firms discount the future at rate δ where 0 < δ < 1. Each consumer buys exactly one unit of the product.
(a) Suppose consumers are perfectly informed about prices. The lowest priced firm captures the whole market. The market is split equally if the firms set the same price.
i. Firms compete for a single period. Identify all Nash equilibria to this game. Explain carefully. [4 marks]
ii. Firms compete over an infinite horizon. For what discount factors (δ) are the following (grim-trigger) strategies sustainable? Explain.
p =〈 0(34) her(nei) ise(er)firm has deviated [4 marks]
(b) Suppose consumers are imperfectly attentive: the market share for firmi is given by
....
0, if pj < min{p, pi} or pi > max{pj , p}
. γ, if p < pj < pi < p
si(p, p, p) =〈．
, ifpi = pj
. α , if p < pi < pj < p
『．1, ifpi < min{p, pj} or pj > max{pi , p},
where α = 9/17 and γ = 8/17; and p and 
p are the lowest and highest prices set on the equilibrium path, respectively. Firms compete over an infinite horizon.
i. For what δ are the following strategies sustainable? Explain.
p =〈 0(17) her(nei) ise(er)firm has deviated [2 marks]
ii. For what δ are the following strategies sustainable? Explain. [Note: you may ignore
deviations that involve raising price.]
...
34 in odd periods if neither firm has deviated p =〈．6 in even periods if neither firm has deviated
『．0 otherwise [5 marks]
4. 3 types of car are available for sale on the used car market in equal numbers. L, M, and H type cars have qualities of 0, 6000, and 9000, respectively, but are indistinguishable to buyers. Buyer and seller valuations for cars are given by
Ub(t , p) =〈！bt - p
『 0
Us(t , p) =〈 p t
『 0
if there is a sale
otherwise
if there is a sale
otherwise,
where t is the quality of the car and b > 1. Negotiation between buyer and seller takes place as follows: the seller makes a take-it-or-leave-it offer; then the buyer decides whether to buy the car or not. (There is no haggling.)
(a) Under what conditions (if any) is there a Nash equilibrium in which all types of car are sold? [3 marks]
(b) Under what conditions (if any) is there a Nash equilibrium in which only L and M type cars are sold? [3 marks]
(c) Under what conditions (if any) is there a Nash equilibrium in which only M and H type cars are sold? [2 marks]
(d) Mike the mechanic can spot an L type car. Mike charges 1000 for an inspection. Mike can handle any volume of requests. Under what conditions (if any) is there a Nash equilibrium in which only M and H type cars are sold? [3 marks]
(e) Suppose Mike is unavailable. However, sellers of H type cars can have the quality of their car certified and guaranteed for a price of 1000. Under what conditions (if any) is there a Nash equilibrium in which only H type cars are sold? [4 marks]
2023-06-15