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Chapter 12/Between Competition and Monopoly
CHAPTER 12
BETWEEN COMPETITION AND MONOPOLY
TEST YOURSELF
1. Using game theory, set up a payoff matrix similar to one that Volkswagen’s management
might employ in analyzing the problem presented in Discussion Question 5.
The payoff matrix for Ford might be Table 1:
TABLE 1
Volkswagon
Hire Singer Cut Price New Product
Hire Singer
2. Test Yourself Question 2 at the end of Chapter 11 presented cost and demand data for a
monopolist and asked you to find the profit-maximizing solution. Use these same
data to find the revenue-maximizing solution. In terms of the firm’s MR, explain
why the answers are different.
The revenue-maximizing solution occurs at an output of 250,000 gallons, where
marginal revenue is zero. At this output, total revenue is a maximum, $40,000. If the firm
expanded to an output of 300,000 gallons, marginal revenue would be negative, and total
3. In the payoff matrix in Table 2, which is Firm B’s dominant strategy? Show the
calculation that leads to that conclusion.
In Table 2, we can see that if Firm A chooses the Low-Tech option, Firm B would
be better off choosing the High-Tech option since it would get a payoff of $12 million
4. You are given a payoff matrix for a zero-sum game. You see that for one pair of strategy
choices by the two firms, A’s payoff is 9 and B’s payoff is 6. For a second set of
strategy choices, A’s payoff is 7. What is B’s payoff?
Chapter 12/Between Competition and Monopoly
DISCUSSION QUESTIONS
1. How many real industries can you name that are oligopolies? How many operate
under monopolistic competition? Perfect competition? Which of these is most difficult
to find in reality? Why do you think this is so?
Some oligopolistic industries are wireless service, steel, chemicals, automobiles,
cigarettes, beer, petroleum, home appliances, aircraft and tires. Some industries in
2. Consider some of the products that are widely advertised on television. By what kind
of firm is each produced—a perfectly competitive firm, an oligopolistic firm, or
another type of firm? How many major products can you think of that are not
advertised on TV?
Most TV advertising is done by oligopolistic firms, for example beer, automakers,
and computer companies. A smaller firm, and particularly a perfect competitor, does not
3. In what ways may the small retail sellers of the following products differentiate their
goods from those of their rivals to make themselves monopolistic competitors:
hamburgers, radios, cosmetics?
In all three products, retailers differentiate themselves by the location and design
4. Pricing of securities on the stock market is said to be carried out under conditions in
many respects similar to perfect competition. The auto industry is an oligopoly. How
often do you think the price of a share of Ford Motor Company’s common stock
changes? How about the price of a Ford Escape? How would you explain the
difference?
The price of Ford common stock changes many times a day. The price of a Ford
Escape changes usually once a year—perhaps more often if there are discount schemes or
Chapter 12/Between Competition and Monopoly
5. Suppose that Volkswagen hires a popular singer to advertise its compact automobiles.
The campaign is very successful, and the company increases its share of the
compact-car market substantially. What is Ford likely to do?
If Volkswagon’s advertising campaign succeeds in increasing its market share,
6. A new entrant, Bargain Airways, cuts air fares between Eastwich and Westwich by 20
percent. Biggie Airlines, which has been operating on this route, responds by cutting
fares by 35 percent. What does Biggie hope to achieve?
This is an example of “predatory pricing.” Biggie hopes to set a price so low that
Bargain will be unable to compete and be driven out of business. Furthermore, other
7. If air transportation were perfectly contestable, why would Biggie Airlines (see
Discussion Question 6) fail to achieve the ultimate goal of its price cut?
If air transportation were perfectly contestable, Bargain could exit the industry
8. Which of the following industries are most likely to be contestable?
a. Aluminum production
b. Barge transportation
c. Computer manufacturing
d. Explain your answers.
Barge transportation is likely to be contestable, because barges can easily be
moved into or out of any geographical area, without a big expense. Aluminum and
9. Since the deregulation of air transportation, a community served by a single airline is
no longer protected by a regulatory agency from monopoly pricing. What market
forces, if any, restrict the ability of the airline to raise prices as a pure monopolist
would? How effective do you think those market forces are in keeping airfares down?
A single airline serving a community is not a pure monopoly. It is restricted from
setting a monopoly price by the competition from other forms of transportation, such as
10. Explain, for a repeated game:
a. Why it may be advantageous to have the reputation of being a tough guy who
Chapter 12/Between Competition and Monopoly
always takes revenge against anyone who harms your interests.
b. Why it may be advantageous to have a reputation of irrationality
(a) If Firm A is a “tough guy,” it will always strike back at hostile actions by
Firm B, even if those hostile acts harm its own interests. Once B becomes convinced
