Question

AA / Suppose that Boeing and Rolls-Royce Holdings are the sole producers of a particular jet engine. The two firms currently charge the same price for their products. If neither firm reduces the price of its engine, each firm earns $36 million in profit. If both firms reduce their prices, then each firm will earn $10 million in profit. If one firm reduces its price and the other does not, then the firm that reduces price will earn a profit of $50 million while the other firm will earn a profit of $5 million.

1/ If the firms can operate as a cartel, then

A/each firm will reduce its pric

.B/ each firm will maintain its current price.

C/Boeing will reduce its price and Rolls-Royce Holdings will maintain its current price

D/ Rolls-Royce Holdings will reduce its price and Boeing will maintain its current price

2/ Assuming that collusion is not a possibility, the Nash equilibrium occurs when

A.	each firm reduces its price.

B.	each firm maintains its current price.

C. Rolls-Royce Holdings reduces its price and Boeing maintains its current price.

D. Boeing reduces its price and Rolls-Royce Holdings maintains its current price.

BB/ Suppose there are two breakfast restaurants in your college town, Waffle Kingdom and Flip’s Flapjacks, and they decide to operate collusively as a cartel. If both restaurants abide by the cartel’s agreement, then each will earn $100,000 in profit. If both restaurants cheat on the cartel’s agreement, then each will earn $25,000 in profit. If one restaurant cheats and the other abides by the agreement, then the cheater will earn a profit of $150,000 while the firm that abides will have a loss of $12,500.

1 The most profitable combined outcome for the two restaurants would be

a/for both restaurants to abide by the cartel’s agreement.

b/	for both restaurants to cheat on the cartel’s agreement.

c/	for Waffle Kingdom to cheat on the agreement and Flip’s Flapjacks to abide by the agreement.

d/ There is not a profitable outcome for both restaurants.

2/

The Nash equilibrium for the two restaurants would be

a/for both restaurant abide by the cartel’s agreement.

b/	for both restaurants cheat on the cartel’s agreement.

c/for Waffle Kingdom to cheat on the agreement and Flip’s Flapjacks to abide by the agreement.

d/There is no Nash equilibrium for firms Waffle Kingdom and Flip’s Flapjacks.

 

Answer 1

AA/ 1 When both the firms are acting as a cartel, then they would maintain their current price. This is because in that case, both the firms are earning $36 million in profit. Since here, cartels are formed in an oligopolistic industry, agreements would be made on such matters as setting minimum or target prices (price fixing), reducing total industry output, fixing market shares, allocating customers and others. If neither firm reduces the price of its engine, each firm earns $36 million in profit. If both firms reduce their prices, then each firm will earn $10 million in profit. If one firm reduces its price and the other does not, then the firm that reduces price will earn a profit of $50 million while the other firm will earn a profit of $5 million. Analysing the different cases of price change we see that the both the firms are earning maximum if they maintain their price.

2. Assuming that collusion is not a possibility, the Nash equilibrium occurs when Rolls-Royce Holdings reduces its price and Boeing maintains its current price.

Explanation:  During Nash equilibrium, if each player has chosen a strategy and no player can benefit by changing strategies while the other players keep theirs unchanged, then the current set of strategy choices and the corresponding payoffs constitutes a Nash equilibrium.

For example, Amy and Tom are in Nash equilibrium if Amy is making the best decision she can, taking into account Tom's decision while Tom's decision remains unchanged, and Tom is making the best decision he can, taking into account Amy's decision while Amy's decision remains unchanged. Likewise, a group of players are in Nash equilibrium if each one is making the best decision possible, taking into account the decisions of the others in the game as long as the other party's decision remains unchanged.

BB/1 The most profitable combined outcome for the two restaurants would be a/for both restaurants to abide by the cartel’s agreement because in this case both are earning $100, 000 So that is the most profitable for the two.

BB/2Nash equilibrium occurs when c/for Waffle Kingdom to cheat on the agreement and Flip’s Flapjacks to abide by the agreement.