CEA Market Structures and Competition 5 — Questions and Answers
Question 1: Game theory's Nash equilibrium in an oligopoly is defined as a situation where:
- Firms collectively maximize joint profit through coordination
- Each firm's strategy is a best response to the strategies of all other firms (Correct answer)
- The government sets output quotas to prevent overproduction
- All firms earn zero economic profit in the long run
Correct answer: Each firm's strategy is a best response to the strategies of all other firms
A Nash equilibrium occurs when no firm can improve its payoff by unilaterally changing its strategy, given the strategies chosen by all rivals.
Question 2: Which of the following best illustrates tying as an anticompetitive practice?
- A firm sells two complementary goods at a discounted bundle price
- A seller requires buyers of its dominant product to also purchase a separate tied product (Correct answer)
- A company lowers prices in markets where competitors are weak
- A manufacturer grants exclusive territories to its distributors
Correct answer: A seller requires buyers of its dominant product to also purchase a separate tied product
Tying forces buyers of a primary (tying) good to also purchase a secondary (tied) good, potentially leveraging market power from one market into another.
Question 3: Network externalities contribute to monopoly power by:
- Reducing the marginal cost of production as output expands
- Increasing the value of a product as more users adopt it, locking consumers into one platform (Correct answer)
- Allowing the firm to perfectly price-discriminate across users
- Eliminating barriers to entry by attracting venture capital investment
Correct answer: Increasing the value of a product as more users adopt it, locking consumers into one platform
Positive network externalities create a self-reinforcing cycle where the dominant platform becomes more valuable as adoption grows, raising switching costs for consumers.
Question 4: The merger of two firms in the same industry (horizontal merger) is most likely to raise antitrust concern when:
- The post-merger HHI falls below 1,500
- The post-merger HHI exceeds 2,500 and increases by more than 200 points (Correct answer)
- The combined firm achieves economies of scale that lower consumer prices
- The merger involves firms in unrelated product markets
Correct answer: The post-merger HHI exceeds 2,500 and increases by more than 200 points
U.S. DOJ/FTC guidelines flag horizontal mergers as presumptively anticompetitive when the resulting HHI exceeds 2,500 with a delta above 200 points.
Question 5: Bundling as a pricing strategy is most profitable for a firm when:
- Consumer valuations for the two goods are positively correlated
- Consumer valuations for the two goods are negatively correlated (Correct answer)
- Marginal costs of both goods are high relative to consumer valuations
- All consumers have identical valuations for both goods
Correct answer: Consumer valuations for the two goods are negatively correlated
Negative correlation in valuations means that consumers who highly value one good value the other less, making a bundle extract more total surplus than separate pricing.
Question 6: An effective limit pricing strategy by an incumbent monopolist sets price:
- Equal to marginal cost to maximize consumer welfare
- Low enough that a potential entrant cannot earn non-negative profit if it enters (Correct answer)
- At the monopoly level to signal quality to entrants
- Above average total cost to deter entry via excess profit signals
Correct answer: Low enough that a potential entrant cannot earn non-negative profit if it enters
Limit pricing keeps price below the level that would attract entry by ensuring potential entrants expect losses post-entry, sacrificing some profit to deter competition.
Question 7: Which outcome is characteristic of Bertrand competition with differentiated products (as opposed to homogeneous products)?
- Price is driven to marginal cost for all firms
- Firms maintain prices above marginal cost and earn positive profit in equilibrium (Correct answer)
- The market collapses to a single firm due to price undercutting
- All consumer surplus is transferred to producers
Correct answer: Firms maintain prices above marginal cost and earn positive profit in equilibrium
Product differentiation softens Bertrand competition because consumers are not perfectly willing to switch, allowing firms to hold prices above marginal cost and earn positive profit.
CEA Market Structures and Competition 5
Game theory's Nash equilibrium in an oligopoly is defined as a situation where: