Oligopoly worksheet

Oligopoly: answer key

1. 1. (B) Mutual interdependence is the hallmark of oligopoly: each firm's pricing and output decisions directly shape what rivals do and vice versa. (A) is wrong because oligopolies can sell identical or differentiated products. (C) is backwards; high barriers to entry are what keep the number of firms small. (D) describes perfect competition, not oligopoly, because these firms have real pricing power.

2. 2. (B) Both choosing low prices is the Nash equilibrium because neither firm can improve its payoff by unilaterally switching to high prices, since doing so would just mean losing customers to the rival who stays low. (A) is the cooperative outcome both firms would prefer, but it's unstable since each firm is tempted to undercut. (C) isn't stable because the high-price firm would immediately want to switch. (D) describes repeated-game dynamics, not a one-shot prisoner's dilemma.

3. 3. (B) Exceeding quotas is the classic example of cartel cheating. Each member boosts its own revenue by pumping more oil than agreed, even though collective overproduction undermines the high price the cartel worked to establish. (A) deals with price stickiness, not cartels. (C) gets it backwards, since OPEC involves explicit agreements, the opposite of tacit coordination. (D) is wrong because OPEC exists precisely to avoid competitive pricing.

4. 4. (B) The kink in the demand curve produces a vertical discontinuity in the MR curve. When MC shifts within that gap, the profit-maximizing quantity and price don't budge. (A) is irrelevant because the model has nothing to do with government regulation. (C) is inaccurate; demand is more elastic above the kink and less elastic below it, not perfectly elastic throughout. (D) mixes up two different models; the kinked demand curve explains stickiness without requiring any collusion.

5. 5. (B) Low Price dominates for Firm A. If B picks High, A earns 10 (Low) vs. 8 (High). If B picks Low, A earns 3 (Low) vs. 1 (High). Low Price wins in both cases. (A) yields less in every scenario. (C) is factually incorrect because the dominant strategy is clearly Low. (D) misunderstands what dominant means; the whole point of a dominant strategy is that A's best choice does not depend on B.

6. 6. (C) Repeated interactions let firms credibly threaten punishment, something like 'undercut me today and I'll undercut you for the next six months', which keeps everyone in line. (A) makes collusion harder because coordinating and monitoring behavior becomes exponentially more difficult with more players. (B) complicates agreements because differentiated products make it tougher to agree on a single price or detect when someone is secretly discounting. (D) makes it hard to tell whether a rival's price cut is cheating or just a response to shifting demand, which erodes trust.

7. 7. (C) The key asymmetry in the model: rivals ignore your price increase because they're perfectly happy picking up the customers you lose. They only match price decreases, to protect their own share. (A) describes cooperative or cartel-type behavior, not what the kinked demand model predicts. (B) is too extreme; rivals don't need to aggressively cut when the price-raiser is already bleeding customers on its own. (D) makes no sense for large firms with billions in sunk costs.

8. 8. (B) (8, 8) is the cooperative optimum: both firms earn 8 by choosing High Price. It's unstable because either firm can defect to Low Price and jump from 8 to 10 while the cooperating firm crashes to 1. That temptation is exactly why real-world cartels collapse. (A) identifies the Nash equilibrium, not the cooperative outcome. Firms are trapped there rather than choosing it voluntarily. (C) is just one cell in the matrix, not an equilibrium or cooperative result. (D) names the right outcome but the wrong mechanism entirely.

9. 9. (B) Cheating dominates for both firms. If the rival colludes, cheating yields 15 vs. 12. If the rival cheats, cheating yields 5 vs. 2. So both cheating gives the Nash equilibrium at (5, 5). The collectively optimal outcome is (12, 12), where both collude and total profit maxes out, but it's unstable because either firm can defect for a higher individual payoff. (A) reverses them. (C) picks asymmetric cells that aren't stable because Y would immediately switch to cheating. (D) wrongly labels an asymmetric cell as the cooperative optimum.

10. 10. (B) Nash equilibrium means each player's strategy is the best response to the other player's strategy, so no one gains from changing their own choice while the other holds constant. It's about individual stability, not collective optimality. (A) describes the cooperative or socially optimal outcome, which is often different from Nash. (C) isn't necessary or sufficient because Nash equilibria can exist with or without dominant strategies. (D) describes a feature of repeated games that might help sustain cooperation, but Nash equilibrium applies to one-shot games just fine.

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