Section 10: Oligopoly and Monopolistic Competition
Question 1
1. The accompanying table shows the demand schedule for vitamin D. Suppose that the
marginal cost of producing vitamin D is zero.
Quantity of vitamin D
demanded (tons)
$8
0
7
10
6
20
5
30
4
40
3
50
2
60
1
70
a. Assume that BASF is the only producer of vitamin D and acts as a monopolist. It currently
produces 40 tons of vitamin D at $4 per ton. If BASF were to produce 10 more tons, what
would be the price effect for BASF? What would be the quantity effect? Would BASF have
an incentive to produce those 10 additional tons?
b. Now assume that Roche enters the market by also producing vitamin D and the market is
now a duopoly. BASF and Roche agree to produce 40 tons of vitamin D in total, 20 tons
each. BASF cannot be punished for deviating from the agreement with Roche. If BASF, on
its own, were to deviate from that agreement and produce 10 more tons, what would be the
price effect for BASF? What would be the quantity effect for BASF? Would BASF have an
incentive to produce those 10 additional tons?
Solution 1
1. a. If BASF produces 10 more tons, it now produces 50 tons and the price would fall to $3 per
b. If BASF produces 10 more tons, the total produced is now 50 tons and the price would fall
Question 2
2. The market for olive oil in New York City is controlled by two families, the Sopranos and the
Contraltos. Both families will ruthlessly eliminate any other family that attempts to enter the
New York City olive oil market. The marginal cost of producing olive oil is constant and
equal to $40 per gallon. There is no fixed cost. The accompanying table gives the market
demand schedule for olive oil.
Price of olive oil
(per gallon)
Quantity of olive oil
demanded (gallons)
$100
1,000
90
1,500
80
2,000
70
2,500
60
3,000
50
3,500
40
4,000
30
4,500
20
5,000
10
5,500
a. Suppose the Sopranos and the Contraltos form a cartel. For each of the quantities given in
the table, calculate the total revenue for their cartel and the marginal revenue for each
additional gallon. How many gallons of olive oil would the cartel sell in total and at what
price? The two families share the market equally (each produces half of the total output of
the cartel). How much profit does each family make?
b. Uncle Junior, the head of the Soprano family, breaks the agreement and sells 500 more
gallons of olive oil than under the cartel agreement. Assuming the Contraltos maintain the
agreement, how does this affect the price for olive oil and the profits earned by each
family?
c. Anthony Contralto, the head of the Contralto family, decides to punish Uncle Junior by
increasing his sales by 500 gallons as well. How much profit does each family earn now?
Solution 2
2. a. The accompanying table shows the total revenue and the marginal revenue for the cartel.
Since a cartel acts like a monopolist, it will maximize profit by producing up to the point
b. Now the Sopranos sell 1,500 gallons and the Contraltos sell 1,000 gallons, for a total output
c. If both the Contraltos and the Sopranos sell 1,500 gallons each, the total output in this
Question 3
3. In France, the market for bottled water is controlled by two large firms, Perrier and Evian.
Each firm has a fixed cost of €1 million and a constant marginal cost of €2 per liter of bottled
water (€1 = 1 euro). The following table gives the market demand schedule for bottled water
in France.
Price of bottled water
(per liter)
Quantity of bottled
water demanded
(millions of liters)
€10
0
9
1
8
2
7
3
6
4
5
5
4
6
3
7
2
8
1
9
a. Suppose the two firms form a cartel and act as a monopolist. Calculate marginal revenue
for the cartel. What will the monopoly price and output be? Assuming the firms divide the
output evenly, how much will each produce and what will each firm’s profits be?
b. Now suppose Perrier decides to increase production by 1 million liters. Evian doesn’t
change its production. What will the new market price and output be? What is Perrier’s
profit? What is Evian’s profit?
c. What if Perrier increases production by 3 million liters? Evian doesn’t change its
production. What would Perrier’s output and profits be relative to those in part b?
d. What do your results tell you about the likelihood of cheating on such agreements?
Solution 3
3. a. The accompanying table calculates total revenue and marginal revenue for the cartel. The
cartel maximizes profit by producing whenever marginal revenue is greater than marginal
b. If Perrier increases production by 1 million liters, the total produced now is 5 million liters
c. If Perrier increases production by 3 million liters, the total produced is 7 million liters and
Question 4
4. To preserve the North Atlantic fish stocks, it is decided that only two fishing fleets, one from
the United States and the other from the European Union, can fish in those waters. Suppose
that the fisheries agreement breaks down, so that the fleets behave noncooperatively. Assume
that the United States and the European Union each can send out either one or two fleets. The
more fleets in the area, the more fish they catch in total but the lower the catch of each fleet.
The accompanying matrix shows the profit (in dollars) per week earned by the two sides.
a. What is the noncooperative Nash equilibrium? Will each side choose to send out one or two
fleets?
b. Suppose that the fish stocks are being depleted. Each region considers the future and comes
to a tit-for-tat agreement whereby each side will send only one fleet out as long as the other
does the same. If either of them breaks the agreement and sends out a second fleet, the
other will also send out two and will continue to do so until its competitor sends out only
one fleet. If both play this tit-for-tat strategy, how much profit will each make every week?
Solution 4
4. a. If the European Union has only one fleet, the United States will have a higher profit if it
Question 5
5. Untied and Air “R” Us are the only two airlines operating flights between Collegeville and
Bigtown. That is, they operate in a duopoly. Each airline can charge either a high price or a
low price for a ticket. The accompanying matrix shows their payoffs, in profits per seat (in
dollars), for any choice that the two airlines can make.
a. Suppose the two airlines play a one-shot game—that is, they interact only once and never
again. What will be the Nash (noncooperative) equilibrium in this one-shot game?
b. Now suppose the two airlines play this game twice. And suppose each airline can play one
of two strategies: it can play either always charge the low price or tit for tat—that is, it
starts off charging the high price in the first period, and then in the second period it does
whatever the other airline did in the previous period. Write down the payoffs to Untied
from the following four possibilities:
i. Untied plays always charge the low price when Air “R” Us also plays always charge the
low price.
ii. Untied plays always charge the low price when Air “R” Us plays tit for tat.
iii. Untied plays tit for tat when Air “R” Us plays always charge the low price.
iv. Untied plays tit for tat when Air “R” Us also plays tit for tat.
Solution 5
5. a. This is a prisoners’ dilemma situation. Whatever Air “R” Us does, it is best for Untied to
b. These are Untied’s payoffs:
Question 6
6. Suppose that Coke and Pepsi are the only two producers of cola drinks, making them
duopolists. Both companies have zero marginal cost and a fixed cost of $100,000.
a. Assume first that consumers regard Coke and Pepsi as perfect substitutes. Currently both
are sold for $0.20 per can, and at that price each company sells 4 million cans per day.
i. How large is Pepsi’s profit?
ii. If Pepsi were to raise its price to $0.30 per can, and Coke did not respond, what would
happen to Pepsi’s profit?
b. Now suppose that each company advertises to differentiate its product from the other
company’s. As a result of advertising, Pepsi realizes that if it raises or lowers its price, it
will sell less or more of its product, as shown by the demand schedule in the accompanying
table.
Price of Pepsi
(per can)
Quantity of Pepsi
demanded (millions of
cans)
$0.10
5
0.20
4
0.30
3
0.40
2
0.50
1
If Pepsi now were to raise its price to $0.30 per can, what would happen to its profit?
c. Comparing your answer to part a(i) and to part b, what is the maximum amount Pepsi
would be willing to spend on advertising?
Solution 6
6. a. i. Pepsi sells 4 million cans at $0.20 for total revenue of $0.20 × 4 million = $800,000. Its
Question 7
7. Schick and Gillette spend huge sums of money each year to advertise their razors in an attempt
to steal customers from each other. Suppose each year Schick and Gillette have to decide
whether or not they want to spend money on advertising. If neither firm advertises, each will
earn a profit of $2 million. If they both advertise, each will earn a profit of $1.5 million. If one
firm advertises and the other does not, the firm that advertises will earn a profit of $2.8
million and the other firm will earn $1 million.
a. Use a payoff matrix to depict this problem.
b. Suppose Schick and Gillette can write an enforceable contract about what they will do.
What is the cooperative solution to this game?
c. What is the Nash equilibrium without an enforceable contract? Explain why this is the
likely outcome.
Solution 7
7. a. See the accompanying payoff matrix.
c. Each firm will consider what its best action is depending on the action of the other firm. If
Question 8
8. Over the last 40 years the Organization of Petroleum Exporting Countries (OPEC) has had
varied success in forming and maintaining its cartel agreements. Explain how the following
factors may contribute to the difficulty of forming and/or maintaining its price and output
agreements.
a. New oil fields are discovered and increased drilling is undertaken in the Gulf of Mexico
and the North Sea by nonmembers of OPEC.
b. Crude oil is a product that is differentiated by sulfur content: it costs less to refine low-
sulfur crude oil into gasoline. Different OPEC countries possess oil reserves of different
sulfur content.
c. Cars powered by hydrogen are developed.
Solution 8
Question 9
9. Suppose you are an economist working for the Antitrust Division of the Justice Department. In
each of the following cases you are given the task of determining whether the behavior
warrants an antitrust investigation for possible illegal acts or is just an example of
undesirable, but not illegal, tacit collusion. Explain your reasoning.
a. Two companies dominate the industry for industrial lasers. Several people sit on the boards
of directors of both companies.
b. Three banks dominate the market for banking in a given state. Their profits have been
going up recently as they add new fees for customer transactions. Advertising among the
banks is fierce, and new branches are springing up in many locations.
c. The two oil companies that produce most of the petroleum for the western half of the
United States have decided to forgo building their own pipelines and to share a common
pipeline, the only means of transporting petroleum products to that market.
d. The two major companies that dominate the market for herbal supplements have each
created a subsidiary that sells the same product as the parent company in large quantities
but with a generic name.
e. The two largest credit card companies, Passport and OmniCard, have required all retailers
who accept their cards to agree to limit their use of rival credit cards.
Solution 9
Question 10
10. In 2015, Anheuser-Busch InBev offered $104.2 billion to acquire SABMiller. The U.S.
Justice Department approved the merger, but only after the two beer giants agreed to sell off
a number of brands, including Miller Lite, Peroni, and Snow (the world’s top selling beer
produced in China). Anheuser-Busch InBev sought the merger to increase its global market
share. The accompanying table presents the global market share before and after the merger
for the world’s ten largest brewers.