Oligopoly and Strategic Behavior

MULTIPLE-CHOICE QUESTIONS

Like a pure monopoly, an oligopoly is characterized by:

a. free entry and exit in the long run.
b. free entry and exit in the short run.
c. significant barriers to entry.
d. all firms in the market producing the socially efficient level of output in the long run.
e. a single firm selling a product with no close substitutes.
ANS: C DIF: Easy TOP: I.A.
REF: What Is Oligopoly?
MSC: Remembering
A monopolistically competitive market consists of many sellers, an oligopoly consists of
__________ seller(s), and a monopoly consists of __________ seller(s).
a. one; one
b. one; two
c. a few; many
d. a few; one
e. many; one
ANS: D DIF: Medium TOP: I.B.
REF: Measuring the Concentration of Industries MSC: Remembering
A monopolistically competitive market consists of __________ seller(s), an oligopoly consists of
__________ seller(s), and a monopoly consists of one seller.
a. one; many
b. one; two
c. a few; many
d. many; one
e. many, a few
ANS: E DIF: Medium TOP: I.B.
REF: Measuring the Concentration of Industries MSC: Remembering
A firm operating in an oligopolistic market has __________ market power compared to a
__________.
a. less; firm operating in a perfectly competitive market
b. the same amount of; firm operating in a perfectly competitive market
c. less; monopolist
d. the same amount of; monopolist
e. more; monopolist
 ANS: C DIF: Medium TOP: I.B.
REF: Measuring the Concentration of Industries MSC: Remembering
Economists measure oligopoly power present in an industry by using:
a. capital ratios.
b. concentration ratios.
c. reserve ratios.
d. inequality ratios.
e. competition ratios.
ANS: B DIF: Easy TOP: I.C.
REF: Measuring the Concentration of Industries MSC: Remembering
Which of the following industries is most likely an oligopoly?
a. restaurant industry
b. airline industry
c. gold-mining industry
d. wheat-growing industry
e. potato-growing industry
ANS: B DIF: Easy TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
Which of the following industries is most likely an oligopoly?
a. wheat industry
b. construction industry
c. cellphone industry
d. computer repair industry
e. house-painting industry
ANS: C DIF: Easy TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
When two or more firms set prices or quantities in unison, economists refer to them as a:
a. cartel.
b. monopoly.
c. monopolistically competitive market.
d. perfectly competitive market.
e. predatory pricing unit.
ANS: A DIF: Easy TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
A __________ agreement among rival firms will most likely specify the price each firm will
charge and the quantity each firm will produce/sell.
a. friendly
b. competitive
c. monopolistic
d. collusive
e. price–quantity
 ANS: D DIF: Easy TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
Oligopolistic markets are __________ because price is __________ marginal cost.
a. socially efficient; equal to
b. socially efficient; less than
c. socially efficient; greater than
d. socially inefficient; less than
e. socially inefficient; greater than
ANS: E DIF: Easy TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
In the United States, __________ prohibit collusion between rivals.
a. competitive arbitration laws
b. immigration laws
c. anticompetition laws
d. union laws
e. antitrust laws
ANS: E DIF: Easy TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
When two or more firms form a __________ agreement and set price and quantity in unison,
economists refer to them as __________.
a. competitive; a cartel
b. collusive; social benefactors
c. collusive; a cartel
d. monopolistically competitive; social benefactors
e. monopolistically competitive; a cartel
ANS: C DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
When a market is characterized by mutual interdependence:
a. one firm’s pricing decision does not affect the market share of any other firm.
b. one firm’s quantity decision does not affect the market share of any other firm.
c. all firms always act in unison to produce the monopoly quantity.
d. the actions of one firm have an impact on the price and output of its competitors.
e. the actions of one firm have no impact on the price and output decisions of its
competitors.
ANS: D DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Remembering
If antitrust laws did not prohibit efforts to restrict competition in markets:
a. no firms would attempt to collude on price and/or quantity.
b. attempts at collusion with rival firms on price and or/quantity would succeed all the
time.
c. attempts at collusion with rival firms would probably fail more often than not.
d. all firms in the economy would earn negative economic profit in the long run.
 e. all firms in the market would earn zero economic profit in the long run.
ANS: C DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MISC: Understanding

The accompanying table shows a small community’s demand for monthly subscriptions to a
streaming movie service. Assume that only two firms (Nextflix and Flixbuster) sell in this market,
that each firm offers the same quality of service and movie selection, and that each firm’s
marginal cost is constant and equal to 0 (zero) due to excess capacity. Use this information to
answer the next six questions.

Price/Month (P) Number of Customers (Q) Total Revenue/Month (TR)

$10 0 $0

$9 100 $900

$8 200 $1,600

$7 300 $2,100

$6 400 $2,400

$5 500 $2,500

$4 600 $2,400

$3 700 $2,100

$2 800 $1,600

$1 900 $900

$0 1,000 $0

.If this market were highly competitive instead of a duopoly, the market price would be
__________ and the quantity of streaming movie subscriptions purchased each month
would be __________.
a. $0; 1,000
b. $2; 800
c. $4; 600
d. $6; 400
e. $8; 800
ANS: A DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying
If this market were a monopoly instead of a duopoly, the market price would be __________ and
the quantity of streaming movie subscriptions purchased each month would be
__________.
a. $0; 1,000
b. $3; 700
c. $5; 500
d. $7; 300
e. $9; 100
 ANS: C DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying
If the two firms operating in this market agreed to each supply one-half of the quantity a
monopolist would supply, the contract would specify that:
a. Nextflix supplies 400 subscriptions and Flixbuster supplies 100 subscriptions.
b. Flixbuster supplies 400 subscriptions and Nextflix supplies 100 subscriptions.
c. Nextflix supplies 0 (zero) subscriptions and Flixbuster supplies 500 subscriptions.
d. Flixbuster supplies 500 subscriptions and Nextflix supplies 0 (zero) subscriptions.
e. Nextflix supplies 250 subscriptions and Nextflix supplies 250 subscriptions.
ANS: E DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying
.An agreement between Nextflix and Flixbuster to each supply 250 subscriptions is an example
of:
a. price discrimination.
b. Bertrand competition.
c. price leadership.
d. collusion.
e. increasing marginal costs.
ANS: D DIF: Medium TOP: II.A.
REF: Collusion and Cartels in a Simple Duopoly Example MSC: Applying
When a third firm enters a market that was previously categorized as a duopoly, the equilibrium
price:
a. will be lower and the equilibrium quantity will be lower.
b. will be higher and the equilibrium quantity will be lower.
c. will be lower and the equilibrium quantity will be higher.
d. will be higher and the equilibrium quantity will be higher.
e. and the equilibrium quantity will not change.
ANS: C DIF: Medium TOP: III.A.
REF: Oligopoly with More Than Two Firms
MSC: Remembering
When more firms enter into a market that was previously characterized as a duopoly, it will:
a. be easier for firms in the market to form a successful cartel.
b. be more difficult for firms in the market to form a successful cartel.
c. be just as difficult for firms in the market to form a successful cartel as it was before the
new firms entered.
d. be impossible for firms in the market to form a successful cartel, whereas before the
new firms entered, it would have been possible.
e. still be impossible for firms in the market to form a successful cartel.
ANS: B DIF: Medium TOP: III.A.
REF: Oligopoly with More Than Two Firms
MSC: Remembering
The _________ effect occurs when the market price either decreases or increases by the
respective entrance or exit of a rival firm in the market.
a. competitive
b. price
c. output
d. market
e. oligopoly
ANS: B DIF: Medium TOP: III.A.
REF: Oligopoly with More Than Two Firms
MSC: Remembering
Three firms are currently producing and selling in a market. When one of the three firms exits
the market, economists expect that the equilibrium price:
a. be lower and the equilibrium quantity will be lower.
b. will be higher and the equilibrium quantity will be lower.
c. will be lower and the equilibrium quantity will be higher.
d. will be higher and the equilibrium quantity will be higher.
e. and the equilibrium quantity will not change.
ANS: B DIF: Medium TOP: III.A.
REF: Oligopoly with More Than Two Firms
MSC: Understanding
Five firms are currently producing and selling in a market. When two more firms enter the
market, economists expect that the equilibrium price:
a. will be lower and the equilibrium quantity will be lower.
b. will be higher and the equilibrium quantity will be lower.
c. will be lower and the equilibrium quantity will be higher.
d. will be higher and the equilibrium quantity will be higher.
e. and the equilibrium quantity will not change.
ANS: C DIF: Medium TOP: III.A.
REF: Oligopoly with More Than Two Firms
MSC: Understanding
Six firms are currently producing and selling in a market. When two of the six firms exit the
market, economists expect that the equilibrium price:
a. will be lower and the equilibrium quantity will be lower.
b. will be higher and the equilibrium quantity will be lower.
c. will be lower and the equilibrium quantity will be higher.
d. will be higher and the equilibrium quantity will be higher.
e. and the equilibrium quantity will not change.
ANS: B DIF: Medium TOP: III.A.
REF: Oligopoly with More Than Two Firms MSC: Understanding
.A _________ consists of a set of players, a set of strategies available to those players, and a
specification of the payoffs to each player for each possible combination of strategies.
a. tournament
 b. competitive market
c. game
d. firm
e. monopolistically competitive market
ANS: C DIF: Easy TOP: IV.A.
REF: How Does Game Theory Explain Strategic Behavior? MSC: Remembering
The branch of economics that studies strategic decision making is called:
a. interdependence theory.
b. game theory.
c. competitive theory.
d. noncompetitive theory.
e. strategic theory.
ANS: B DIF: Easy TOP: IV.A.
REF: How Does Game Theory Explain Strategic Behavior? MSC: Remembering
Economists use _________ to better understand what might happen in situations where strategic
interactions are involved.
a. complexity theory
b. strategic theory
c. competitive theory
d. noncompetitive theory
e. game theory
ANS: E DIF: Easy TOP: IV.A.
REF: How Does Game Theory Explain Strategic Behavior? MSC: Remembering
Economists are more likely to use game theory to analyze a(n):
a. competitive market.
b. monopoly.
c. monopolistically competitive market.
d. oligopoly.
e. monopsony.
ANS: D DIF: Easy TOP: IV.A.
REF: How Does Game Theory Explain Strategic Behavior? MSC: Remembering
When decision-makers face incentives that make it difficult to achieve mutually beneficial
outcomes, we say they are in a(n):
a. oligopoly dilemma.
b. prisoner’s dilemma.
c. prison-guard’s dilemma.
d. monopoly dilemma.
e. competitive dilemma.
ANS: B DIF: Easy TOP: IV.B.
REF: Strategic Behavior and the Dominant Strategy MSC: Remembering
Refer to the accompanying table. If Jane confesses, John will spend _________ years in jail if he
also confesses and _________ years in jail if he keeps quiet.

a. 10; 10
b. 10; 25
c. 10; 0
d. 0; 10
e. 25; 25
ANS: B DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant
Strategy MSC: Applying
Refer to the accompanying table. If Jeff confesses, Gerry will spend _________ years in jail if he
also confesses and _________ years in jail if he keeps quiet.

a. 15; 15
b. 35; 35
c. 0; 35
d. 35; 0
e. 15; 35
ANS: E DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant
Strategy MSC: Applying
Refer to the accompanying table. If Keisha keeps quiet, Larry will spend ________ years in jail
if he confesses and __________ years in jail if he also keeps quiet.
 a. 12; 1.5
b. 1.5; 12
c. 0; 12
d. 12; 12
e. 0; 1.5
ANS: E DIF: Easy TOP: IV.B. REF: Strategic Behavior and the Dominant
Strategy MSC: Applying
When a particular strategy produces a better outcome for a person regardless of the strategies
others choose, we say it is a(n):
a. dominated strategy.
b. dominant strategy.
c. equilibrated strategy.
d. efficient strategy.
e. surplus maximization strategy.
ANS: B DIF: Easy TOP: IV.C.
REF: Strategic Behavior and the Dominant Strategy MSC: Applying
Refer to the accompanying table. Confessing is Eddie’s dominant strategy because:

a. Sharon’s dominant strategy is to keep quiet.

b. he spends more time in jail if he confesses, regardless of whether Sharon confesses or
keeps quiet.
c. he spends less time in jail if he confesses, regardless of whether Sharon confesses or
keeps quiet.
d. he spends the same time in jail by confessing than he would by not confessing.
 e. his decision does not depend on Sharon’s decision.
ANS: C DIF: Medium TOP: IV.C. REF: Strategic Behavior and the Dominant
Strategy
MSC: Applying
Refer to the accompanying table. In the Nash equilibrium of this game, Derrick will go to jail for
___________ years and Brandy will go to jail for _________ years.

a. 0.5; 0.5
b. 25; 25
c. 0.5; 18
d. 0.5; 25
e. 18; 18
ANS: E DIF: Medium TOP: IV.C. REF: Strategic Behavior and the Dominant
Strategy
MSC: Applying
The Nash equilibrium in an oligopolistic market is generally __________ for society than the
outcome under collusion because the price is __________ marginal cost.
a. better; closer to
b. better; further above
c. worse; closer to
d. worse; further above
e. worse; equal to
ANS: A DIF: Difficult TOP: IV.D.
REF: Duopoly and the Prisoner’s Dilemma
MSC: Understanding
Which of the following is an example of collusion?
a. Nike and Reebok compete on price.
b. Dell and Gateway compete on quantity.
c. American Airlines and United Airlines agree to raise prices.
d. Coca-Cola and Pepsi do not attempt to fix prices.
e. Verizon builds more cellphone towers.
ANS: C DIF: Easy TOP: IV.D.
REF: Duopoly and the Prisoner’s Dilemma
 MSC: Applying
The accompanying table shows two firms in a duopoly. Each firm makes its decision
without knowledge of the other firm’s decision. The payoffs for each firm represent
economic profits, and each firm strictly prefers more economic profit than less. In this
game, selling __________ subscriptions a month is a dominant strategy for Flixbuster and
selling __________ subscriptions a month is a dominant strategy for Nextflix.

a. 200; 200
b. 200; 400
c. 400; 200
d. 400; 400
e. 100; 100
ANS: D DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner’s Dilemma
MSC: Applying
The accompanying table shows two firms in a duopoly. Each firm makes its decision without
knowledge of the other firm’s decision. The payoffs for each firm represent economic
profits, and each firm strictly prefers more economic profit than less. If both firms were
able to collude and make their supply decisions collectively, Flixbuster would sell
___________ subscriptions per month and Nextflix would sell ___________ subscriptions
per month.

a. 200; 200
b. 400; 400
 c. 400; 200
d. 200; 400
e. 600; 600
ANS: A DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner’s Dilemma
MSC: Applying
The accompanying table shows two firms in a single-stage duopoly game. Each firm makes its
decision without knowledge of the other firm’s decision. The payoffs for each firm
represent economic profits, and each firm strictly prefers more economic profit than less. If
both firms were able to write a binding contract, this contract would specify that
Bobbles.com agrees to produce _________ bobbleheads and Bobbles R Us agrees to
produce _________ bobbleheads.

a. 5,000; 7,000
b. 7,000; 5,000
c. 7,000; 7,000
d. 5,000; 5,000
e. 12,000; 0
ANS: D DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner’s Dilemma
MSC: Applying
.In January 2011, Coca-Cola and Pepsi agreed to reduce their yearly advertising budgets by $1
million each, and neither firm reneged on the agreement throughout the year. In January
2012, Coca-Cola and Pepsi each announced that their company 2011 profits had increased
by $1 million. Which of the following is a likely explanation for this increase?
a. A new entrant in the market caused Coca-Cola and Pepsi to lose substantial market
share.
b. The government imposed a punitive tax on both firms for producing a beverage that is a
danger to public health.
c. The firms had previously been in a prisoner’s dilemma situation where one firm’s
advertisements were effectively canceling the other firm’s advertisements.
d. Coca-Cola drastically reduced the price of its soda relative to the price of Pepsi’s soda.
e. Pepsi drastically reduced the price of its soda relative to the price of Coca-Cola’s soda.
ANS: C DIF: Medium TOP: IV.E.
REF: Advertising and Game Theory
MSC: Understanding
.The accompanying table shows two firms in a single stage game. Each firm makes its decision
without knowledge of the other firm’s decision. The payoffs for each firm represent
economic profits, and each firm strictly prefers more economic profit than less. In the Nash
equilibrium of this game, Pepsi earns a profit of _________ and Coca-Cola earns a profit of
__________.

a. $67.5 million; $67.5 million

b. $30 million; $30 million
c. $37.5 million; $75 million
d. $75 million; $37.5 million
e. $50 million; $50 million
ANS: E DIF: Medium TOP: IV.E. REF: Advertising and Game Theory MSC:
Applying
Game theorist Robert Axelrod decided to examine the choices that participants make in a long-
run setting. He ran a sophisticated computer simulation in which he invited scholars to
submit strategies for securing points in a prisoner’s dilemma tournament over many rounds.
All the submissions were collected and paired, and the results were scored. After each
simulation, he eliminated the weakest strategy and re-ran the tournament with the
remaining strategies. This evolutionary approach continued until the best strategy
remained. Among all strategies submitted, which strategy dominated?
a. tit-for-tat strategy
b. tit-for-two-tats strategy
c. Axelrod equivalency strategy
d. profit-maximization strategy
e. grim trigger
ANS: A DIF: Easy TOP: IV.F.
REF: Escaping the Prisoner’s Dilemma in the Long Run MSC: Remembering
Player A and Player B are playing a game involving several rounds of a prisoner’s dilemma
where their choices are to “cooperate” or “defect.” After each round ends, one player roles
a six-sided die. If the die lands on 6, the game ends; however, if the die lands on any other
number, the game continues and players play another round. Prior to the game starting, the
players formulate a strategy that specifies what they will do in every possible round they
might find themselves in. If Player A is playing the tit-for-tat strategy, in the:
a. first round, Player A will definitely choose defect.
b. second round, Player A will definitely choose defect.
 c. second round, Player A will choose whatever Player B chose in the first round.
d. second round, Player A will definitely choose cooperate.
e. third round, Player A will definitely choose cooperate.
ANS: C DIF: Medium TOP: IV.F.
REF: Escaping the Prisoner’s Dilemma in the Long Run MSC: Remembering

SHORT-ANSWER QUESTIONS

Compare the social efficiency of oligopolistic market outcomes to perfectly competitive market
outcomes and monopoly outcomes.
ANS:
The equilibrium price in an oligopoly is higher than the equilibrium price in a competitive
market and lower than the equilibrium price in a monopoly. The equilibrium quantity in an
oligopoly is lower than the equilibrium quantity in a competitive market and higher than
the equilibrium price in a monopoly. Social efficiency is maximized in a perfectly
competitive market where price is equal to marginal cost. Because the equilibrium price in
an oligopoly is above marginal cost, the oligopoly outcome is less socially efficient than
the perfectly competitive market outcome. Because the equilibrium price in an
oligopolistic market is closer to marginal cost than the equilibrium price in a monopoly,
the oligopoly outcome is more socially efficient than the monopoly outcome.
DIF: Difficult TOP: I.B. REF: Measuring the Concentration of Industries MSC:
Analyzing
Explain the difference between the price effect and the output effect when a new firm enters a
market.
ANS:
When a new firm enters a market, two effects must be considered: price and output. The
price effect occurs when the market price decreases due to the entrance of a rival firm into
the market. Because the price has fallen, total revenue (and total profit) for all firms falls.
The output effect generates additional revenues (and additional profits) for a new entrant
because the entrant increases the total quantity produced.
DIF: Medium TOP: III.A. REF: Oligopoly with More Than Two Firms
MSC: Understanding
Airline Manufacturer A and Airline Manufacturer B are duopolists in their industry. Explain how
the two firms could collectively benefit if they were to collude and form a cartel. Why might
collusion be difficult?
ANS:
The highest combined profit can be obtained if the two firms were to collectively produce
the quantity that a monopoly would produce and then charge the price that a monopoly
would charge. If the firms were able to coordinate and choose their price and quantity in
unison, they each could benefit by earning a share of the profit that a monopolist would
earn. Collusion might be difficult to maintain because, once a collusive agreement is in
 place, each firm has a private incentive to renege by selling a higher quantity and/or
charging a lower price than its rival.
DIF: Medium TOP: IV.D. REF: Duopoly and the Prisoner’s Dilemma MSC:
Analyzing
Google and Yahoo! are two large search engine companies. Combined, these companies control
a large market share in the search engine industry. Both companies currently advertise their
search engines on television, and each company earns a profit of $550 million. If both
companies were to stop advertising on television, each would earn a profit of $600 million. If
only one company were to stop advertising on television and the other company continued to
do so, the company that stopped advertising would earn a profit of $200 million and the
company that continued to advertise would earn a profit of $800 million.
Assume this is a simultaneous-move game where Google and Yahoo! choose to advertise
or choose not to advertise, and Google and Yahoo! cannot collude. Explain the process of
finding Google’s dominant strategy.
ANS:
When Google chooses to advertise or not to advertise, Google must think about what
Yahoo! will choose. If Yahoo! were to advertise, Google would earn $550 million by
advertising or $200 million by not advertising. If Yahoo! were not to advertise, Google
would earn $800 million by advertising or $600 million by not advertising. Regardless of
what Yahoo! chooses, Google will always earn a higher profit from advertising; therefore,
advertising is Google’s dominant strategy in this game.
DIF: Medium TOP: IV.E. REF: Duopoly and the Prisoner’s Dilemma MSC:
Analyzing