Oligopoly

After reading this chapter, you should know: 1. The unique characteristics of oligopoly. 2. How oligopolies maximize profits. 3. How interdependence affects oligopolists' pricing decisions.

Problems for Chapter 10

1.Suppose the automobile market in the U.S. is divided as follows:

General Motors28% Ford23% Toyota18% Daimler-Chrysler16% All others15%

a) What is the four firm concentration ratio? b) What is the approximate Herfindahl-Hirschman Index?

2.Assume an oligopolist confronts two possible demand curves for its own output, as illustrated below. The first (A) prevails if other oligopolists don’t match price changes. The second (B) prevails if rivals do match price changes.

Price ($)

$10 9 8 7 6 5 4Demand A 3 2 1Demand B

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Quantity (units per period)

a) By how much does quantity demanded change if price is reduced from $10 to $4 and i) Rivals match price cut? ii) Rivals don’t match price cut?

b) By how much does quantity demanded change if price is raised from $4 to $9 and i) Rivals match price hike? ii) Rivals don’t match price hike?

3.Suppose the following schedule summarizes the sales situation confronting an oligopolist in the beverage industry:

Price (per unit) |$0.30 |$0.40 |$0.50 |$0.60 |$0.70 |$0.80 |$0.90 | |Quantity demanded per period (in millions) |10 |9 |8 |7 |6 |5 |4 | |

Using the graph below, a) Draw the demand and marginal revenue curves facing this firm. b) Identify the profit-maximizing rate of output in a situation where marginal cost is constant at $0.20 a unit.

$ 1.00

0.90

0.80

0.70

0.60

0.50

0.40

0.30

0.20

0.10

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(Quantity in millions)

4.Suppose Nike and Adidas spend enormous sums of money every year to promote their athletic wear, hoping to steal customers from each other. Furthermore, assume each year they have to decide whether or not they should spend more money on advertising. If neither firm advertises, each of them will earn $5 million. If both advertise, each will earn $2 million in profit. If one firm advertises and the other does not, the firm with the promotions will earn a profit of $3 million and the other firm will earn a mere $0.5 million. Use a payoff matrix to present this problem.

5.For the problem above: a) If the probability of an Adidas decision to advertise is 90 percent, what is the expected payoff to Nike’s decision to advertise?

b) If the probability of Adidas not advertising even though Nike does not is 20 percent, what is expected payoff to Nike’s decision to not to advertise?

c) What should Nike do?