ECON6034 COMPETITION, REGULATION AND BUSINESS STRATEGY Fall 2021 Midterm Exam
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ECON6034 COMPETITION, REGULATION AND BUSINESS STRATEGY
Fall 2021 Midterm Exam
[40 points in total, counting toward 20% of your grade]
Question 1 (10 points) This question is on Green and Porter (1984) in which firms compete in quantity and that they do not observe each other’s quantity. Recall these elements of the model
• The context is the repeated quantity game but there is imperfect information.
• In each period, firms privately choose quantities and then observe price.
• Price depends on firms’ quantities and an unobserved iid demand shock.
• A deviation in quantity cannot be directly observed: Lower price is indicative of cheating but can also be due to demand shock. We say there is imperfect monitoring.
Equilibrium
• During the collusive phase, firms choose some designated collusive quantities. Although no firms deviates, the price is random and may be low due to demand shock. If the realized price falls below a threshold, then firms switch to a punishment phase which is static Nash equilibrium quantities for T periods; after which they return to the collusive phase.
a) Please explain why the above can be an equilibrium outcome. Why does not any firm have an
incentive to produce more than the agreed upon amount even though they can only observe the market price but not each other’s quantity?
b) We argue that this model predicts a stochastic process on price which is subject to regime switches. Please describe the stochastic process with regime changes.
Question 2 (15 points) Consider a chain store selling in two markets.
• One potential entrant in each market
• An entrant first arrives in period 1 with a potential entrant in market 1, and another entrant
arrives in period 2 with a potential entrant in market 2.
• Consider the following payoffs in each market:
— Incumbent’s profit without entry: I(M) = 100
— Incumbent’s profit with entry if incumbent predates: I(A) = 40
— Incumbent’s profit with entry if incumbent accomodates: I(P) = −10
— Entrant’s profit with entry: E(A) = 40 >0 > E(P) = −10
a) Please explain why predatory pricing will not be used in equilibrium to deter entry. Try to recall the logic described in the lecture handout.
b) Suppose there is only one period, one market and one potential entrant instead, and that with probability pthe incumbent is “strong” and with probability (1 − p) it is “weak” . A strong incumbent will predate regardless and a weak incumbent has payoff as described in the question. What is the cutoff value of pabove which the entrant will not enter the market.
Question 3 (15 points): Suppose U is the sole incumbent upstream firm and D is the sole incumbent downstream firm. There are no other firms in the industry, except that potential entrant Firm E is considering entering the upstream market. Suppose for both U and E, if any of them stays active in the market, the firm has to incur a very small fixed cost of e>0.
The timing of the game goes as follows. First, E decides whether to enter the market. If E enters the market, U decides whether to stay active in the market.
The following table describes each firm’s profit depending on whether Firm Eenters the market and whether U exits the market after E enters the market, in the absence of exclusive contract(s):
Firm U Firm D
Firm E
E doesn’t enter
−e+60
100
0
E enters and
U does not exit −e
170
−e+20
E enters
and U exits
0
120
−e+70
a) Please reproduce the following game tree and fill out the payoffs of U, D, and E (labeled as Π ,
ΠD , and ΠE ) at the end nodes of the game tree. Then solve for the equilibrium.
Exit
Do not enter
U Exits? |
b) Suppose only U can offer an exclusive contract to D. Would there be a mutually beneficial exclusive contract between U and D which allows both firms to earn more than not signing an exclusive contract? Explain your answer.
c) Suppose only E can offer an exclusive contract to D. Would there be a mutually beneficial exclusive contract between E and D which allows both firms to earn more than not signing an exclusive contract? Explain your answer. [Remark: Be careful in your analysis. The answer may be different if the assumption is changed to “If E does not offer an exclusive contract, then U can decide whether to offer and exclusive contract.”]
2023-02-04