Problem Set #8                                                                        Name:________________

PPA 723                                 

Professor John McPeak

 

1)      McDonalds and Burger King are thinking of putting a franchise on Euclid.  The following table represents their net benefits of putting up a restaurant.

 

If McDonalds builds, they will make 10,000 per day net profit if Burger King also builds, 30,000 per day if Burger King does not build. 

 

If Burger King builds, they will make -5,000 per day net profit if McDonalds builds, and 20,000 per day if McDonalds does not build.

 

If a firm does not build, it does not make any net profit.

 

 

 

Burger King

Build

Don’t Build

McDonalds

Build

10        -5

30            0

Don’t Build

0         20

0              0

 

a)   Describe the full set of best response strategies for each firm.

 

 

 

 

 

 

b)  What is the predicted outcome (Nash equilibrium) if each plays their best response strategy?

 

 

 

 

 

 

c)  Does this change if we give Burger King first mover status?

 

2)  Market structure, externalities, and taxation.  The inverse demand curve is given as p=100-q.  The supply curve is p=10+q.

 

 

  1. What is the equilibrium price quantity pair if the market structure is perfectly competitive?

 

 

 

 

 

 

  1. What is the equilibrium price quantity pair if production of the good imposes an externality defined by MCE= 0.5*q and the market structure is perfectly competitive?

 

 

 

 

 

 

 

 

  1. What Pigovian tax can be defined as a specific tax on producers in the perfectly competitive market to arrive at the socially optimal price- quantity pair?

 

 

 

 

 

 

 

 

 

 

 

 

  1. In terms of economic efficiency, does it matter whether we place this tax on consumers or producers?  Why does it matter or why does it not matter?

 

 

 

 

 

 

 

  1. What is the equilibrium price quantity pair if the market structure is a monopoly?

 

 

 

 

 

 

 

 

 

 

 

  1. Is total welfare higher or lower with the monopoly result or the perfectly competitive result in the presence of the production externality?  Show using areas on a graph (and calculate the size of these areas if you feel like extra practice).

 

 

3) Binghamton has the “Broome County Regional” and Ithaca has “Tompkins County Regional” airport.  Currently, Broome County gets $30,000 per day from running their own airport, while Tompkins County gets $50,000 per day (these are net of all possible considerations).  Under state guidance, a new regional airport will be constructed if each municipality agrees to close their own airport.  If they do agree to close their airport, they will evenly split the profit generate of the jointly managed “Southern-Tier Regional Airport”, which is estimated to be $120,000 per day.  If Broome County closes its airport, but Tompkins County does not, it is estimated that Broome County will earn $0 per day, while Tompkins will earn $75,000 per day.  If Tompkins county closes its airport, but Broome county does not, Broome county is estimated to earn $70,000 per day, and Tompkins county earns $0 per day.  In normal form, this can be written as follows.

 

                                    Broome County

 

Tompkins County

 

Close (BC)

Don’t Close (BC)

Close (TC)

$60,  $60

   $0,  $70

Don’t Close  (TC)

$75,    $0

 $50,  $30

Payoffs are in thousands of dollars.

           

a)                Describe the full set of best response strategies for each county in turn.

 

 

 

b)                Will the regional airport be built if each firm plays their own best response strategy?

 

 

 

 

 

 

 

 

4) Race to the bottom.  Maryland and Virginia are considering reducing welfare benefits.  Currently, Maryland is spending 10 million per year on welfare programs, and Virginia is spending 20 million per year.  Given their close proximity and high population density in the DC area, there is likely to be migration from one state to another if one state cuts its benefits and the other does not.  In fact, research has indicated that the following pattern is going to hold.  NOTE THESE ARE COSTS, NOT PAYOFFS, SO HIGH IS “BAD”, LOW IS “GOOD”

 

 

Virginia

 

 

Maryland

 

Reduce benefits

Maintain Current Benefits

Reduce benefits

7                16

6                          23

Maintain Current Benefits

12              15

10                        20

 

a.       Define the full set of best response strategies for each state.

 

 

 

 

 

 

 

 

b.      What is the outcome (the Nash Equilibrium) of this game.

 

 

 

 

 

 

c.       Describe in words the nature of the externality in this game?

 

 

 

 

 

d.      Does the outcome of this game resolve whether society is made better off by reducing or maintaining current benefits?  Why or why not?