HW5

1) Refer to the game.
Player 2
T1 T2 T3
S1 10, 0 5, 1 4, -200
Player 1
S2 10, 100 5, 0 0, -100
Which of the following pairs of strategies constitute a Nash equilibrium of the game? (Explain)
A. S1, t1 A. Not a NE since B would deviate to strategy T2.
B. S1, t2 B. Is NE since no player has any incentive to deviate. Player 1 get the same profit
of 5 for playing S1 or S2. Player 2 get the maximum profit for playing T2 for S1.
C. S2, t1 C. Is NE since no player has any incentive to deviate. Player 1 get the same profit
of 10 for playing S1 or S2. Player 2 get the maximum profit for playing T1 for S2.
D. S1, t2 and S2, t1 D. Both choice B & C are NE.
2) There are two existing firms in the market for computer chips. Firm A knows how to reduce the
production costs for the chip and is considering whether to adopt the innovation or not. Innovation
incurs a fixed setup cost of C, while increasing the revenue. However, once the new technology is
adopted, another firm, B, can adopt it with a smaller setup cost of C/2 after observing A’s strategy. If A
innovates and B does not, A earns $20 in revenue while B earns $0. If A innovates and B does likewise,
both firms earn $15 in revenue. If neither firm innovates, both earn $5. Under what condition will firm B
have an incentive to adopt if firm A adopts the innovation and secondly under what condition will firm A
innovate?
A. C > 30
B. C < 30
C. 10 > C > 0
D. 35 > C > 25?
To have B adopt, the payoff from adopting

should be higher than the payoff from not
adopting, therefore:
15 - C/2 > 0 C < 30
Firm A will innovate when (15 - C > 5) or

(20 – C > 5):
15 – C > 5 C < 10
3) Given the information in question 2, and if C = 15, which is the Nash perfect equilibrium of the game?
A. A innovates, B does not.
B. A innovates, B innovates.
C. Neither firm innovates.
D. None of the preceding answers is correct
If C=15, the maximum profit for both firms Is (5, 5)

when both firm don`t innovate.
4) Refer to the normal-form game of advertising shown below.

Firm B
Advertise Do Not Advertise
Advertise 0, 0 175, 10
Firm A
Do Not Advertise 10, 175 125, 125
Suppose there is a 20 percent chance that the advertising game depicted above will end next period.
What is the present value to firm B of cheating on the collusive strategy {do not advertise, do not
advertise}?
A. $0
B. $10
C. $125
D. $175 Payoff from B cheating is 175 (A don’t advertise, B advertise. Then profits are 10, 175)
5) Given the information in question 4, the collusive agreement {(not advertise, not advertise)} is:
A. sustainable since $175 < $625.
It is sustainable since the payoff from following the
B. unsustainable since $175 < $625.
trigger strategy is: 125 / 0.2 = 625 and 175 < 625.
C. sustainable since $10 < $50.
D. unsustainable since $10 < $50
6) Given the normal-form game in question 4, suppose there is a 90 percent chance that the advertising
game will end next period. The collusive agreement {(not advertise, not advertise)} is:
A. sustainable since $175 > $138.89.
It is unsustainable since the payoff from following the
B. unsustainable since $175 > $138.89.
trigger strategy is: 125 / 0.9 = 138.89 and 175 > 138.89
C. sustainable since $11.11 < $50.
D. unsustainable since $11.11 < $50.
7) Suppose that Verizon Wireless has hired you as a consultant to determine what price it should set for
calling services. Suppose that an individual’s inverse demand for wireless services in the greater Boston
area is estimated to be P = 100 − 33Q and the marginal cost of providing wireless services to the area is
$1 per minute. What is the optimal two-part price that you would suggest to Verizon?
A. Charge a fixed fee = $95.5 and a usage fee of $1 per minute.
B. Charge a fixed fee = $3 and a usage fee of $0.33 per minute.
C. Charge a fixed fee = $148.50 and a usage fee of $1 per minute.
D. Charge a fixed fee = $3 and a usage fee of $3 per minute
Since Verizon Wireless engages in optimal two-part pricing, the firm will sell the product at MC, (P = 1)
Allowing Verizon Wireless to extract consumer surplus (148.5) as a calling services fee.
8) Suppose that the demand for a monopolist's product is estimated to be Qd = 100 − 2P and its total
costs are C(Q) = 10Q. Under first-degree price discrimination, the optimal price(s), number of total units
exchanged, profit, and consumer surplus extracted are:
A. P = $30; Q = 40, Profit = $800; CS = $400.
B. 10 ≤ 𝑃 ≤ 100; Q = 80; Profit = $1,600; CS = $1,600.
C. 10 ≤ 𝑃 ≤ 50; Q = 80, Profit = $1,600; CS = $0.
D. P = $30; Q = 40, Profit = $600; CS = $0.
Q = 100 − 2P inverse demand function is: P = 50 − 0.5Q when monopolist would set a single price,
they would equate MC to MR: MR = 50 − Q = MC = 10 Q = 40 P = 50 − 0.5 × 40 = 30
However, under first-degree price discrimination, the monopolist tries to extract all consumer surplus.
Therefore, will set the price differently for all consumers that are willing to pay a price P at
least equal to MC = 10. P = 50 − 0.5Q = 10 Q = 80
9) A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent
chance the firm's demand curve will be P = 40 − Q and a 50 percent chance it will be P = 60 − Q. The
marginal cost of the firm is MC = 3Q. The expected profit-maximizing price is:
A. $10.
B. $20.
C. $30.
D. $40
For profit maximization E(MR)=MC, MR1= 40 - 2Q = 3Q MR2= 60 - 2Q = 3Q

Case1: E(MR1) = 0.5 (40 - 2Q) = 3Q Q = 4 units
Case2: E(MR2) = 0.5 (60 - 2Q) = 3Q Q = 6 units
Expected price = 50% (40 - 10) + 50% (60-10) = 0.5 (30) + 0.5 (50) = 40
10) Suppose that there are two types of cars, good and bad. The qualities of cars are not observable but
are known to the sellers. Risk-neutral buyers and sellers have their own valuation of these two types of
cars as follows:
Types of Cars Buyer's Valuation Seller's Valuation
Good (50% probability) 5,000 4,500
Bad (50% probability) 3,000 2,500
When buyers do not observe the quality, what happens in the market and explain why this outcome is
observed based on the economic phenomenon behind it?
A. Both good and bad cars are traded.
B. Only good cars are traded.
C. Only bad cars are traded.
D. Neither good nor bad cars are traded.
Buyer's expected value = 0.5*5000 + 0.5*3000 = 4000

Seller's expected value = 0.5*4500 + 0.5*2500 = 3500
Price is between (3500 < P < 4000) which is less than seller's valuation of good cars. Therefore, only bad
cars are traded.
Hani Alharbi
G201468160

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HW5

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1) Refer to the game.

To have B adopt, the payoff from adopting

15 - C/2 > 0 C < 30

Firm A will innovate when (15 - C > 5) or

If C=15, the maximum profit for both firms Is (5, 5)

4) Refer to the normal-form game of advertising shown below.

For profit maximization E(MR)=MC, MR1= 40 - 2Q = 3Q MR2= 60 - 2Q = 3Q

Buyer's expected value = 0.55000 + 0.53000 = 4000

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