4ECON005C Exploring Economics - Microeconomics

Tutorial week 10. Game Theory and Competitive Strategy

MULTIPLE CHOICE QUESTIONS

Question 1. A dominant strategy can best be described as:

A) a strategy taken by a dominant firm.
B) the strategy taken by a firm in order to dominate its rivals.
C) a strategy that is optimal for a player no matter what an opponent does.
D) a strategy that leaves every player in a game better off.
E) all of the above

Question 2. Which of the following is NOT a key component of every game?

A) Strategies
B) Players
C) Payoffs
D) Cooperation

Question 3. Your economics professor has decided that your class will not be graded on a
curve but on an absolute scale. Therefore, it is possible for every student in the class to get
an "A." Your grade will not depend in any way on your classmates' performance. Based on
this information, you decide that you should study economics three hours each day,
regardless of what your classmates do. In the language of game theory, your decision to
study three hours each day is:
A) a dominant strategy.
B) a minimax strategy.
C) a maximin strategy.
D) a Prisoners' Dilemma.

Scenario to Question 4.
Consider the following game:
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Question 4. Which of the following is true about the game in Scenario?

A) ABC's dominant strategy is to offer a rebate.
B) ABC's dominant strategy is not offer a rebate.
C) XYZ's dominant strategy is to offer a rebate.
D) XYZ's dominant strategy is not offer a rebate.
E) Both ABC and XYZ offer a rebate as a dominant strategy.

Question 5. Consider the following game in which two firms decide how much of a
homogeneous good to produce. The annual profit payoffs for each firm are stated in the cell
of the game matrix, and Firm A's payoffs appear first in the payoff pairs:

Firm B - low output Firm B - high output

Firm A - low output 300, 250 200, 100
Firm A - high output 200, 75 75, 50

What are the dominant strategies in this game?

A) Both firms produce low levels of output.
B) Both firms produce high levels of output.
C) Firm A's dominant strategy is to produce low levels of output, but Firm B does not have a
dominant strategy.
D) Firm B's dominant strategy is to produce low levels of output, but Firm A does not have a
dominant strategy.
E) Neither firm has a dominant strategy.

Question 6. What does it mean to say that a game is in "extensive form"?

A) Strategies are described, rather than just numbered.
B) All payoffs are shown.
C) The game is presented as a matrix.
D) The game is presented as a decision tree.
E) The game is written out as often as the situation calls for it to be played.

Question 7. A Nash equilibrium occurs when:

A) a player can choose a strategy that is optimal regardless of its rivals' actions.
B) each firm chooses the strategy that maximizes its minimum gain.
C) each firm is doing the best it can, given its opponents' actions.
D) there is no dominant firm in a market.
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Question 8. Why does cooperative behavior break down in games with finite endpoints?
A) Each player has an incentive to deviate from a cooperative strategy during the last period.
B) A Nash equilibrium in pure strategies is not possible in finite repeated games.
C) Finite games have the same outcomes as one-period games, and cooperation is not
possible in one-period games.
D) A Nash equilibrium is only possible in mixed strategies in finite repeated games, but all of
the probabilities assigned to particular strategies approach zero as the number of finite game
periods becomes large. Thus, we cannot evaluate the expected payoffs in these games.

Question 9. What is the dominant strategy for bidders in an English oral auction?
A) Keep bidding until all other bidders quit, regardless of your reservation price.
B) Bid until the previous bid price equals the reservation price of the last bidder.
C) Bid until the first-price and second-price bids are equal.
D) Stop bidding once the price exceeds your reservation price.

Question 10. An auction in which a seller begins by offering an item for sale at a relatively
high price and then reduces the price by fixed amounts until receiving a bid is known as a:
A) Dutch auction.
B) English auction.
C) second-price auction.
D) sealed-bid auction.

QUESTIONS FOR DISCUSSION

Question 11. What is the difference between a cooperative and a noncooperative game? Give an
example of each.

Question 12. Explain the meaning of a Nash equilibrium. How does it differ from an
equilibrium in dominant strategies?
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EXERCISES

Question 13. Two competing firms are each planning to introduce a new product. Each will
decide whether to produce Product A, Product B, or Product C. They will make their
choices at the same time. The resulting payoffs are shown below.

Firm 2
A B C
A −10, −10 0, 10 10, 20
Firm 1 B 10, 0 −20, −20 −5, 15
C 20, 10 15, −5 −30, −30

A) Are there any Nash equilibria in pure strategies? If so, what are they?
B) If both firms use maximin strategies, what outcome will result?
C) If Firm 1 uses a maximin strategy and Firm 2 knows this, what will Firm 2 do?

Question 14. We can think of U.S. and Chinese trade policies as a prisoners’ dilemma. The
two countries are considering policies to open or close their import markets. The payoff
matrix is shown below.
China
Open Close
Open 10, 10 5, 5
U.S.
Close −100, 5 1, 1

A) Assume that each country knows the payoff matrix and believes that the other country will
act in its own interest. Does either country have a dominant strategy? What will be the
equilibrium policies if each country acts rationally to maximize its welfare?
B) Now assume that China is not certain that the United States will behave rationally. In
particular, China is concerned that U.S. politicians may want to penalize China even if that
does not maximize U.S. welfare. How might this concern affect China’s choice of strategy?
How might this change the equilibrium?

Question 15. Joanna has a credit card account with InfinBank. InfinBank's available strategies
are to raise Joanna's credit card interest rate or do nothing. Joanna's available strategies are to
transfer her InfinBank account balance to another creditor or do nothing. If InfinBank raises
Joanna's interest rate and Joanna does nothing, InfinBank increases profits by $1,000 while
Joanna receives -$1,000. If InfinBank raises Joanna's interest rate and Joanna transfers her
account to another creditor, InfinBank receives -$300 while Joanna receives -$100. If
InfinBank does nothing and Joanna does nothing, each player receives $0. If InfinBank does
nothing and Joanna transfers her account to another creditor, InfinBank receives -$300 while
Joanna receives -$150.

Diagram the game tree for this sequential game. Indicate any Nash equilibria.
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Homework

Question 16. Defendo has decided to introduce a revolutionary video game. As the first firm
in the market, it will have a monopoly position for at least some time. In deciding what
type of manufacturing plant to build, it has the choice of two technologies. Technology A
is publicly available and will result in annual costs of
CA(q) = 10 + 8q
Technology B is a proprietary technology developed in Defendo’s research labs. It
involves a higher fixed cost of production but lower marginal costs:
CB(q) = 60 + 2q
Defendo must decide which technology to adopt. Market demand for the new product is
P = 20 − Q, where Q is total industry output.
➢ Suppose Defendo were certain that it would maintain its monopoly position in
the market for the entire product lifespan (about five years) without threat of
entry. Which technology would you advise Defendo to adopt? What would be
Defendo’s profit given this choice?