AP Micro Game Theory and Strategic Behavior 1 — Questions and Answers
Question 1: What is a Nash Equilibrium in game theory?
- A situation where all players cooperate to maximize joint profits
- A situation where no player can benefit by unilaterally changing their strategy (Correct answer)
- A situation where one firm sets prices and all others follow
- A situation where government intervention forces a stable market outcome
Correct answer: A situation where no player can benefit by unilaterally changing their strategy
A Nash Equilibrium is a stable outcome in which no individual player can increase their payoff by changing only their own strategy, given the strategies of all other players.
Question 2: In the classic prisoner's dilemma, what is each prisoner's dominant strategy?
- Always cooperate (stay silent) to protect both prisoners
- Cooperate only if the other prisoner cooperates first
- Defect (confess) regardless of what the other prisoner does (Correct answer)
- Choose randomly to prevent the other prisoner from predicting their move
Correct answer: Defect (confess) regardless of what the other prisoner does
Defecting is a dominant strategy because confessing yields a better personal outcome whether the other prisoner stays silent or also confesses.
Question 3: Which of the following best describes the market structure of an oligopoly?
- Many small firms producing identical products with free entry and exit
- A single firm controlling the entire market output
- A few large firms that are mutually interdependent in their pricing and output decisions (Correct answer)
- Many firms selling differentiated products with no barriers to entry
Correct answer: A few large firms that are mutually interdependent in their pricing and output decisions
An oligopoly consists of a small number of large firms whose decisions significantly affect one another, creating strategic interdependence.
Question 4: How is a dominant strategy identified in a payoff matrix?
- It is the strategy that maximizes the combined payoff for all players
- It is the strategy that yields the highest payoff regardless of what the other player chooses (Correct answer)
- It is the strategy that always results in a Nash Equilibrium
- It is the strategy that minimizes the maximum possible loss
Correct answer: It is the strategy that yields the highest payoff regardless of what the other player chooses
A dominant strategy is one that produces a higher payoff for a player than any alternative strategy, no matter what strategy the opponent selects.
Question 5: Why does collusion among oligopolists tend to be unstable over time?
- Government antitrust laws always detect and break up collusive agreements immediately
- Firms have no incentive to charge the agreed-upon price once collusion begins
- Each individual firm has an incentive to cheat by secretly lowering its price to capture more customers (Correct answer)
- Collusive agreements require identical production costs among all participants
Correct answer: Each individual firm has an incentive to cheat by secretly lowering its price to capture more customers
Although collusion raises industry profits, each firm can earn even more by secretly undercutting the agreed price, giving every member an incentive to defect from the agreement.
Question 6: The kinked demand curve model of oligopoly assumes that rival firms will:
- Match price increases but ignore price decreases
- Match price decreases but ignore price increases (Correct answer)
- Neither match price increases nor price decreases
- Always match both price increases and price decreases
Correct answer: Match price decreases but ignore price increases
Under the kinked demand model, rivals match price cuts (fearing loss of market share) but do not follow price increases (hoping to attract customers away), creating a kink that explains price rigidity.
Question 7: In the prisoner's dilemma, why do both players end up with a suboptimal outcome even though both are acting rationally?
- Both players lack information about the available payoffs in the game
- Each player rationally follows their dominant strategy, producing a collectively worse outcome than cooperation would have achieved (Correct answer)
- The game is designed so that no equilibrium exists
- Players are prevented from communicating by a third-party enforcer
Correct answer: Each player rationally follows their dominant strategy, producing a collectively worse outcome than cooperation would have achieved
Individual rationality leads each player to defect, but when both defect they reach an outcome that is worse for both than if they had both cooperated — a core insight of the prisoner's dilemma.
AP Micro Game Theory and Strategic Behavior 1
What is a Nash Equilibrium in game theory?