Practice Questions Chapter 1 1. People respond to incentives ...

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2. The following information describes the demand schedule for a uniquetype of apple. This type of apple can only be produced by two firmsbecause they own the land on which these unique trees spontaneouslygrow. As a result, the marginal cost of production is zero for theseduopolists, causing total revenue to equal profit.a. Complete the following table.b. If the market were perfectly competitive, what price and quantity wouldbe generated by this market? Explain.c. If these two firms colluded and formed a cartel, what price and quantitywould be generated by this market? What is the level of profitgenerated by the market? And what is the level of profit generated byeach firm?d. If one firm cheats and produces one additional increment (five units) ofproduction, what is the level of profit generated by each firm?e. If both firms cheat and each produces one additional increment (fiveunits) of production (compared to the cooperative solution), what is thelevel of profit generated by each firm?Practice Questions to accompany Mankiw & Taylor: Economics 42
f. If both firms are cheating and producing one additional increment ofoutput (five additional units compared to the cooperative solution), willeither firm choose to produce an additional increment (five more units)?Why? What is the value of the Nash equilibrium in this duopoly market?g. Compare the competitive equilibrium to the Nash equilibrium. In whichsituation is society better off? Explain.h. Describe what would happen to the price and quantity in this market ifan additional firm were able to grow these unique apples. (Do notattempt to calculate quantitative changes – the direction of change isall that’s required.)i. Use the data from the duopoly example above to fill in the boxes of theprisoners' dilemma. Place the value of the profits earned by eachduopolist in the appropriate box in Exhibit 1.Exhibit 1j. What is the solution to this prisoners' dilemma? Explain.k. What might the solution be if the participants were able to repeat the"game?" Why? What simple strategy might they use to maintain theircartel?Practice Questions to accompany Mankiw & Taylor: Economics 43
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