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# Game theory and profit maximization

Game theory and profit maximization

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1. Game theory

Look at the link on Moodle about McDonald’s market share in May of this year. Compare McDonald’s to Subway. Both firms have introduced lower cost items on the menu to try and increase market share. They could have kept their prices higher. You will have to make some assumptions and estimates. You can assume that if there had been no change in prices then there would be no change in market shares.

a. i) How will you compare the data for McDonald’s lower prices (\$1 to \$7.79) with Subway’s low price of \$4? [1]

ii) Make a payoff matrix for the two companies and explain the 4 outcomes that you have chosen. [4]

iii) We know the outcome already but what strategy has caused this to happen? [2]

b. Two firms are planning to set up in Prince George, Wholesale Sports and Old Navy. They sell similar kinds of goods. If they both set up they will lose \$2m; if they both stay away they will make no extra profit; if one sets up and the other doesn’t, the one that sets up will make \$2m and the one that doesn’t will make nothing.

i) Put this into a matrix [1]

ii) What kind of game is this? Explain. [2]

iii) How will the outcome be reached? Explain. [3]

c. Why do we usually study competitive games in economics? In your opinion, is this realistic – explain your answer. [3]

2. Profit Maximisation

a) Prince George City Council recently voted to keep the Pine Valley Golf Course rather than sell it for an estimated \$10m to \$17m. Keeping it will involve running costs of about \$1.5m. As economists what would you say is the cost of this decision? Explain your answer. [2]

b) We saw in the news story that McDonald’s has increased its market share by selling lower price goods. This may reduce profits. Does this make our assumption of profit maximising firms invalid? Explain. [2]

c) If a firm faces a perfectly elastic demand curve at what point should it produce and why? [2]

d) A firm produces in a competitive market with the following costs: TC = 200 + 2q2

i) If the price is \$60, what quantity should be produced? Explain your answer. [3]

ii) What will the profit be? [2]

iii) What is the minimum price that the firm will operate at? Explain. [3]

iv) The firm has not taken into account that they could have invested its \$200 and earned 30% interest. What would the firm do in this case? [4]

Last Updated on February 11, 2019

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