1. Chapter 10 Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life
Odd-numbered Qs.

2. Problem #1, Chapter 10
In studying for his economics final, Sam is concerned about only two things: his grade and the amount of time he spends studying. A good grade will give him a benefit of 20; an average grade, a benefit of 5; and a poor grade, a benefit of 0. By studying a lot, Sam will incur a cost of 10; by studying a little, a cost of 6. Moreover, if Sam studies a lot and all other students study a little, he will get a good grade and they will get poor ones. But if they study a lot and he studies a little, they will get good grades and he will get a poor one. Finally, if he and all other students study the same amount of time, everyone will get average grades. Other students share Sam’s preferences regarding grades and study time.

3. Solution to Problem #1 (1)
A) Model this situation as a two-person prisoner’s dilemma in which the strategies are to study a little and to study lot, and the players are Sam and all other students. Include the payoffs in the matrix
Payoff = benefit - cost
Think of all possible combinations of outcomes
Sam studies a lot while all others also study a lot
Sam’s payoff: 5-10 =-5; all others’ payoff: 5-10=-5
Sam studies a lot but all others study a little
Sam’s payoff: =10; all others’ payoff: 0 – 6 = -6

4. Solution to Problem #1 (2)
Sam studies a little but all others study a lot
Sam’s payoff: 0-6 = -6; all others’ payoff: 20-10= 10
Sam studies a little while all others also study a little
Sam’s payoff: 5-6= -1; all others’ payoff: 5-6= -1
Put all these possible combinations into a payoff matrix

5. Solution to Problem #1 (3)
All others
Study a lot
Study little
Sam
-5 for Sam;
-5 for others
10 for Sam;
-6 for others
Study a little
-6 for Sam;
10 for others
-1 for Sam;
-1 for others

6. Solution to Problem #1 (4)
B) What is the equilibrium outcome in this game? From the students’ perspective, is it the best outcome?
To find the equilibrium outcome, we first need to find out how will each player behave in the preparation for final
The dominant strategy refers to the best strategy for an individual player regardless of what all players do
The dominated strategy refers to the strategy that is always inferior to the dominant strategy
In this question, both Sam and all others have a dominant strategy of studying a lot

7. Solution to Problem #1 (5)
Therefore, each will follow the best strategy by studying a lot for preparation for final
Equilibrium outcome: both studying a lot
As a result, both Sam and all others will end up with an average grade of 5 or a payoff of -5
However, this is actually not a best outcome
From the students’ perspective, for everyone to study a little would turn out to better than the equilibrium outcome

8. Problem #3, Chapter 10 (1)
Blackadder and Baldrick are rational, self-interested criminals imprisoned in separate cells in a dark medieval dungeon. They face the prisoners’ dilemma displayed in the matrix
Assume that Blackadder is willing to pay $1000 for each year by which he can reduce his sentence below 20 years. A corrupt jailer tells Blackadder that before he decides whether to confess or deny the crime, she can tell him Baldrick’s decision. How much is this information worth to Blackadder?

9. Problem #3, Chapter 10 (2) Blackadder Confess Deny Baldrick
5 years for each
0 year for
Baldrick;
20 years for
Blackaddder
Blackadder;
1 year for
each

10. Solution to Problem #3 (1)
To find out how much does the information worth to Blackadder, we will need to know whether the information is useful
If one knows the other’s dominant strategy, one will know what will the other do regardless what one does
Based on the payoffs in the matrix, we know:
Baldrick has a dominant strategy of confess
Blackadder has a dominant strategy of confess
The equilibrium outcome is thus confess

11. Solution to Problem #3 (2)
Therefore, Baldrick will confess no matter Blackadder confesses or denies
The information from the corrupt jailer is thus useless
It is worth nothing to Blackadder

12. Problem #5, Chapter 10
Imagine yourself sitting in your car in a campus parking lot that is currently full, waiting for someone to pull out so that you can park your car. Somebody pulls out, but at the same moment a driver who has just arrived overtakes you in an obvious attempt to park in the vacated spot before you can. Suppose this driver would be willing to pay up to $10 to park in that spot and up to $30 to avoid getting into an argument with you. (That is, the benefit of parking is $10 and the cost an argument is $30.) At the same time he guesses, accurately, that you too would be willing to pay up $30 to avoid a confrontation and up to $10 to park in the vacant spot.

13. Solution to Problem #5 (1)
A) Model this situation as a two-stage decision tree in which his bid to take the space is the opening move and your strategies are (1) to protest and (2) not to protest. If you protest (initiate an argument), the rules of game specify that he has to let you that the space. Show the payoffs at the end of each branch of tree.
Start from the first node: the other driver either leave you the parking lot or overtake the parking lot
If the driver leaves you the parking lot, you and the driver will not engage in any form of argument or dispute
You will finally get a benefit of $10 as having your car parked

14. Solution to Problem #5 (2)
However, if the driver overtakes the parking lot, you will end having either a defer or a protest against the act of the driver
If you protest, you will get a payoff of -$20 and the driver will have a payoff of -$30
Why are that?
Payoff = Benefit – Cost
Your payoff: $10 - $30 = -$20
The driver’s payoff: -$30
If you defer, you will get a payoff of $0 and the driver will have a payoff of $10

15. Solution to Problem #5 (3)
If you defer, you will get a payoff of $0 and the driver will have a payoff of $10
Why are that?
If the driver gets the parking spot, he or she will enjoy the associated benefit ($10)
Both of you and the driver do not have to enter an argument
The other driver leaves you the spot
$10 for you; $0 for the driver
-$20 for you; -$30 for the driver
You protest
The other driver overtakes the parking spot
You defer
$0 for you; $10 for the driver

16. Solution to Problem #5 (4)
B) What is the equilibrium outcome?
The driver will overtake the parking spot and you will have to wait for another spot
Why?
Given in the question that he has made an accurate guess that you would be willing to pay up to $30 to avoid a confrontation and pay up to $10 for a parking spot
The driver understands that if he or she overtakes the parking spot, you will probably not protest but defer to another spot as your payoff is -$20 if protest but $0 if defer
You will minimize your loss but deferring to another spot

17. Solution to Problem #5 (5)
C) What would be the advantage of being able to communicate credibly to other driver that your failure to protest would be a significant psychological cost to you?
Suppose the other driver perceived that you would experience a psychological cost of $30 not only if you entered into a dispute, but also if you failed to protest his unjust behaviour
The driver would then think your net cost of becoming involved in an argument would be $0
This perception would change your protest payoff to $10
As a result, the driver would no longer gain from taking the parking spot

18. Problem #7, Chapter 10
Consider the following game, called matching pennies, which you are playing with a friend. Each of you has a penny hidden in your hand, facing either heads up or tails up (you know which way the one in your hand is facing). On the count of “three,” you simultaneously show your pennies to each other. If the face-up side of your coin matches the face-up side of your friend’s coin, you get to keep the two pennies. If the faces do not match, your friend gets to keep the pennies.
A) Who are the players in the game? What are each player’s strategies? Construct a payoff matrix for the game.

19. Solution to Problem #7 (1)
Elements of the game
Players: you and your friend
Strategies: head or tail
4 possible outcomes:
2 heads- you get the other penny from your friend who will end up have nothing
2 tails- you get the other penny from your friend who will end up have nothing
1 head from your side and 1 tail from your friend’s side- your penny will be taken by your friend
1 tail from your side and 1 head from your friend’s side- your penny will be taken by your friend

20. Solution to Problem #7 (2)
You
Head
Tail
Your friend
1 for you;
-1 for your friend
-1 for you;
1 for your
friend
1 for your friend
-1 for your

21. Solution to Problem #7 (3)
B) Is there a dominant strategy? If so, what?
No. There are no dominant strategy
No single strategy that is best regardless of what your friend’s coin outcome
Head and tails offer same payoff to both you and your friends
C) Is there an equilibrium outcome? If so, what?
No. There is no equilibrium outcome
Every time when your friend plays one side, you will want to match that side

22. Problem #9, Chapter 10 (1)
Two airplanes manufacturers are considering the production of a new product, a 150-passenger jet. Both are deciding whether to enter the market and produce the new planes. The payoff matrix is as follows (payoff values are in millions of dollars):

23. Problem #9, Chapter 10 (2) Airbus Produce Don’t produce Boeing
-5 for each
100 for Boeing;
0 for Airbus
0 for Boeing;
100 for Airbus
0 for
each

24. Problem #9, Chapter 10 (3)
The implication of these payoffs is that the market demand is large enough to support only one manufacturer. If both firms enter, both will sustain a loss.
A) Identify two possible equilibrium outcomes in this game
Based on the payoff matrix above, we know that
Given that one company produces (does not produce), the other company will get a higher payoff by not producing (producing)
1-equilibrium outcome: Airbus produces while Boeing does not produce
2-equilibrium outcome: Boeing produces while Airbus does not produce

25. Problem #9, Chapter 10 (4)
B) Consider the effect of a subsidy. Suppose the European Union decides to subsidize the European producer, Airbus, with a check for $25 million if it enters the market. Revise the payoff matrix to account for this subsidy. What are the new equilibrium outcome?
Due to the subsidy from EU, producing becomes a dominant strategy for Airbus
Given Airbus is producing, Boeing will start away from the market
For the revised payoff matrix, all Airbus’ payoffs are added by 25

26. New equilibrium is shown in blue
Problem #9, Chapter 10 (5)
　New equilibrium is shown in blue
Airbus
Produce
Don’t produce
Boeing
20 for Airbus;
-5 for Boeing
100 for Boeing;
0 for Airbus
125 for Airbus;
0 for Boeing
0 for
each

27. Problem #9, Chapter 10 (6)
C) Compare the two outcomes (pre- and post-subsidy). What qualitative effect does the subsidy have?
Without the subsidy, both airplane manufacturers kind of compete on the same ground
Either one will enter the market but which will enter remains uncertain
However, with the subsidy from EU, Airbus is “granted” a dominant strategy ensuring its production and eliminating production by Boeing