profit only depends on its own output and
pricing decisions and not on the pricing and
output decisions of other firms.
5. The prisoner’s dilemma implies that it is very dif-
ficult to sustain collusion in a short- term agree–
ment. Because the short- run payoff for “cheating”
is so high in the prisoner’s dilemma that it makes
unless they can collude. A dominant strategy is
one in which that par tic u lar strategy produces a
better outcome for that person, regardless of what
strategies the other players choose.
When each player in a game has a dominant
strategy, the Nash equilibrium consists of each
player playing his or her dominant strategy.
However, it is pos si ble for a Nash equilibrium to
exist in a game even if the players don’t have a
events that night— one is a tractor pull and the
other is a dance. Neither student knows where
the other might go, so they decide on their own
which event to attend. Each is better off if they
attend the same event. Notice that there is no
Questions for Review
1. Oligopoly is a type of market that shares key
characteristics with both a mono poly and
monopolistic competition; however, an oligopoly
is more competitive than a mono poly and less
competitive than monopolistic competition. As
in monopolistic competition, products are
2. Adding an additional firm makes it more difficult
for an oligopolistic industry to form and main-
tain an effective cartel. This is because as more
firms enter the market, the incentive for each
firm to lower the price and steal output increases.
This is most easily seen using an example. Sup–
pose we start out with a duopoly— two firms.
When a third firm enters, supply increases, which
forces prices down. Now, each firm has less mar-
market.
4. Game theory matters for oligopoly because each
firm’s actions affect the pricing and output deci-
sions of the other firms. Therefore, when decid-
ing what to produce or how much to charge, a
Solutions to Chapterfi13 Text Prob lems
Establishing a new airline would mean negoti-
ating with airports, buying aircraft, and hiring
pi lots and flight attendants.
market is high.
c. Fast food is not an oligopoly; it is another
example of monopolistic competition. There
are too many firms, and competition is very
fierce. In addition, there are no barriers to
entry in the fast food market: anyone can rent
or lease a building and cook fast food.
d. Wheat is not an oligopoly; it is perfect
reputation as a quality sports equipment firm.
Without this type of reputation, it would be
difficult for other firms to enter this market.
f. The college bookstore on your campus is an
oligopoly with a compelling locational
advantage that gives it significant mono poly
power. There is no other store that provides
exactly what it does— the precise books needed
interest (it is their dominant strategy) to answer the
last question. If they answer the question cor–
rectly, they will get full credit. If they do not
answer the question at all and somebody else
does, they will get a zero. This reasoning works
7. The Sherman Antitrust Act bans monopolies and
cartels. The Clayton Act is even more restrictive
and penalizes corporations that try to reduce
8. Network externalities occur when the number of
consumers that use a good influences the quan-
tity demanded. This means that a firm that can
establish a large customer base early on is more
able to attract consumers and keep its consumers
from switching to rival firms. This matters for an
oligopolist because a firm that can establish a
large customer base may be able to become the
Study Prob lems
1. It is pos si ble that sales restrictions on the hours
alcohol can be sold on Sunday actually help
liquor stores by lowering output and therefore
raising prices for every one. Consider the case
raised in Figure13.2in the text, where each
2. a. Passenger airlines are a good example of an oli-
gopoly. Each airline has some market power on
the routes it flies (e.g., Alaska Airlines has mar-
ket power for routes within Alaska), and there
are very high barriers to entry into this market.
dominant strategy is also to work less hard.
c. The Nash equilibrium is for both of you to
work less hard. In this equilibrium, neither of
you would have an incentive to change your
decision. Each of you is better off doing that,
regardless of what the other person is doing.
You each play your dominant strategy, and this
where each person works hard.
7.
Price Quantity TR MR
(per oz.) (oz.)
$1,000 1,000 1,000,000 1,000
900 2,000 1,800,000 800
800 3,000 2,400,000 600
700 4,000 2,800,000 400
and output should be 8,000 ounces.
b. In order to solve this prob lem, you need to
know the marginal revenue (MR) for a
monopolist. To calculate the total revenue,
multiply price by quantity. The marginal
revenue is the difference in revenue between
each quantity increase divided by the increase
in quantity. A monopolist will keep producing
as long as MR # MC but will stop once MR ! MC
answers), while guessing at least gives the student
the possibility of getting the question correct.
Hints and Common Errors: Think about
how your class might be able to collude and skip
the last question. You could all get together
before the exam and agree to skip the last
the next assignment or talk to them outside class.
5. a. Network externalities aren’t really impor tant
for gas stations. Any car can fill up at any gas
station, so there are no real switching costs.
Also, there’s no bandwagon effect: nobody
knows where you fill up with gas, and even if
they did, they prob ably wouldn’t care.
b. The AARP may have some network
of partners. If a dating Web site can establish
itself with a large customer base in the
beginning, it will be able to charge a higher
price and still attract customers. People will be
willing to pay in order to be matched with a
larger pool rather than join a free Web site with
only a few members.
6. a. Your dominant strategy is to work less hard.
This is better for you no matter what your part-
market, and The Pizza Factory will earn only
$20,000. If the Pizza Factory pays Perfect Pies
$15,000 not to enter the market, then the Pizza
Factory can earn $35,000, which is better than
sive features (small, compact machines with faster
brewing technology), then it may gain more mar–
ket share if the consumers think they would ben-
efit from these features. But this is a one- time
gain only! Keurig would use the same or even
more aggressive strategies (emphasizing the vari-
ety of coffee, tea, and soups it offers to commer-
cial and individual customers). However, in the
long run, it is likely that Keurig remains the mar–
ket leader because both firms know they would
lose if they keep competing with each other, as
shown in the repeated game model.
12. The model that explains this phenomenon is
equally, each firm will produce 2,000 ounces
and charge a price of $700/ounce. They will
each earn a revenue of $1,400,000.
d. If one firm decides to increase production by
9. a. The dominant strategy of the Pizza Factory is
to set a high price. Regardless of what Perfect
Pies does, the Pizza Factory is better off by set-
ting a high price. If Perfect Pies enters, the
Pizza Factory makes $20,000 instead of $10,000
by setting a high price. If Perfect Pies does not
enter, the Pizza Factory makes $50,000 instead
of $25,000. Either way, it is better for the Pizza
Factory to set a high price.
b. Perfect Pies does not have a dominant strategy.
c. The Nash equilibrium is that the Pizza Factory
charges a high price, and Perfect Pies enters the
market.