AP_Krugman_Textbook

650 section 12 Market Structures: Imperfect Competition

Module 65 AP Review

Check Your Understanding

1. Suppose world leaders Nikita and Margaret are engaged in an
   arms race and face the decision of whether to build a missile.
   Answer the following questions using the information in the
   payoff matrix below, which shows how each set of actions will
   affect the utility of the players (the numbers represent utils
   gained or lost).

Build

missile

Build missile

Margaret

Nikita

Don’t

build

missile

Don’t build

missile

8

–10 8

–10 –20

–20

0

0

Solutions appear at the back of the book.

a. Identify any Nash equilibria that exist in this game, and

explain why they do or do not exist.

b. Which set of actions maximizes the total payoff for Nikita

and Margaret?

c. Why is it unlikely that they will choose the payoff-maximizing

set of actions without some communication?

2. For each of the following characteristics of an industry, explain
   whether the characteristic makes it more likely that oligopolists
   will play noncooperatively rather than engaging in tacit
   collusion.
   a. Each oligopolist expects several new firms to enter the
   market in the future.
   b. It is very difficult for a firm to detect whether another firm
   has raised output.
   c. The firms have coexisted while maintaining high prices for a
   long time.

Tackle the Test: Multiple-Choice Questions

1. Each player has an incentive to choose an action that, when
   both players choose it, makes them both worse off. This
   situation describes
   a. a dominant strategy.
   b. the prisoners’ dilemma.
   c. interdependence.
   d. Nash equilibrium.
   e. tit for tat.


2. Which of the following types of oligopoly behavior is/are
   illegal?
   I. tacit collusion
   II. cartel formation
   III. tit for tat
   a. I only
   b. II only
   c. III only
   d. I and II only
   e. I, II, and III


3. A situation in which each player in a game chooses the action
   that maximizes his or her payoff, given the actions of the other
   players, ignoring the effects of his or her action on the payoffs
   received by others, is known as a:
   a. dominant strategy.
   b. cooperative equilibrium.
   c. Nash equilibrium.
   d. strategic situation.
   e. prisoners’ dilemma.
   4. In the context of the Thelma and Louise story in the module,
   suppose that Louise discovers Thelma’s action (confess or don’t
   confess) before choosing her own action.

Based on the payoff matrix provided, Louise will

a. confess whether or not Thelma confessed.

b. not confess only if Thelma confessed.

c. not confess only if Thelma didn’t confess.

d. not confess regardless of whether or not Thelma confessed.

e. confess only if Thelma did not confess.

Don’t

confess

Don’t confess

Confess

Confess

Louise gets

5-year

sentence.

Louise gets

2-year

sentence.

Louise gets

20-year

sentence.

Louise gets

15-year

sentence.

Thelma gets

5-year sentence.

Thelma gets

15-year sentence.

Thelma gets

20-year sentence.

Thelma gets

2-year sentence.

Thelma

Louise