MARKETS. Part Review. Reading Between the Lines SONY CORP. HAS CUT THE U.S. PRICE OF ITS PLAYSTATION 2

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1 Part Review 4 FIRMS AND MARKETS Reading Between the Lines SONY CORP. HAS CUT THE U.S. PRICE OF ITS PLAYSTATION 2 On May 14, 2002 Sony announced it was cutting the cost of its PlayStation 2 by 33 percent, from $299 to $199. PlayStation 2 competes with Microsoft s X-box and Nintendo s Game Cube as the latest generation game consoles. After keeping its price at $299 since it introduced the PlayStation 2 in 2000, Sony lowered the price in May a few days before Microsoft was expected to announce that it was lowering the price of its X- Box from $299 to $199. Both the X-Box and the Game Cube were introduced in For details, go to The Economics Place web site, the Economics in the News archive, Analyze It Sony s PlayStation 2 has by far the largest market share in the latest generation game consoles. Between the X-Box and the Game Cube, Sony likely believes that the X-Box is a closer substitute because its power and features are more similar to those of the PlayStation than is the case for the Game Cube. After Sony announced it was lowering its price, Microsoft made the expected announcement that it, too, was lowering its price. 1. In what type of market is the Sony PlayStation 2 sold? 2. Assume that Microsoft is Sony s only competitor and describe the prisoners dilemma game Sony and Microsoft are playing. 3. Sony kept the price of the PlayStation 2 at $299 in the months preceding and the months following the introduction of the X-Box. What might Sony have done instead to try to keep Microsoft from entering the market? 239

2 240 PART REVIEW 4 Mid-Term Examination Chapter Partners of a partnership have a. limited liability. So do shareholders in a corporation. b. limited liability. Shareholders in a corporation have unlimited liability. c. unlimited liability. So do shareholders in a corporation. d. unlimited liability. Shareholders in a corporation have limited liability. 12. An economically efficient method of production a. is always technologically efficient. b. lies below the production function. c. lies below the supply curve. d. may not always be technologically efficient. 13. An electrician quits her current job, which pays $30,000 per year. She can take a job with another firm for $40,000 per year or work for herself. The opportunity cost of working for herself is a. $10,000. b. $30,000. c. $40,000. d. $ In their relation to a firm s managers, shareholders act a. as agents. b. as principals. c. in loco parentis. d. as a cabinet for advice. Chapter If a firm s marginal product of labor is greater than its average product of labor, then an increase in its use of labor necessarily will a. reduce its total product. b. raise its average product of labor. c. raise its marginal product of labor. d. not change its average product of labor. 16. The additional cost of producing an additional unit of output is the firm s a. MC. b. ATC. c. AVC. d. AFC. 17. In general, diseconomies of scale occur a. as output expands at low levels of production. b. through the entire range of production. c. as output expands at high levels of production. d. whenever the slope of the total product curve is positive.

3 FIRMS AND MARKETS The intersection of the MC and ATC curves is the point at which a. average total cost is minimized. b. average variable cost is minimized. c. average fixed cost is minimized. d. total product is maximized. Chapter In perfect competition, which is the case? a. A firm can influence the price of the good. b. There are many sellers. c. There are restrictions on entry. d. All firms sell a slightly different product. 10. A firm should decrease its output as long as its a. average total revenue exceeds its average total cost. b. average total revenue exceeds its average variable cost. c. marginal cost exceeds its marginal revenue. d. marginal revenue exceeds its marginal cost. 11. At a firm s shutdown point, its average variable cost equals its a. average total cost. b. average fixed cost. c. price. d. None of the above. 12. A perfectly competitive firm finds that at its current output, MR = MC and P > ATC. Then this firm will a. expand its output and lower its price. b. reduce its output and raise its price. c. shut down. d. not change its production nor its price. Chapter Public franchises are a. legal barriers to entry. So are patents. b. legal barriers to entry. Patents are natural barriers to entry. c. natural barriers to entry. So are patents. d. natural barriers to entry. Patents are legal barriers to entry. 14. The demand curve for a monopoly a. lies above its marginal revenue curve. b. lies on its marginal revenue curve. c. lies below its marginal revenue curve. d. is horizontal.

4 242 PART REVIEW When a single-price monopoly is maximizing its profit, then the level of output it produces is a. efficient because profit is maximized. b. inefficient. c. efficient because MR = MC. d. efficient because costs are minimized. 16. Which of the following occurs with BOTH a perfect price discriminating monopoly and a single-price monopoly? a. The level of output is inefficient. b. All consumer surplus goes to the monopoly. c. Both create deadweight loss. d. There is a redistribution of surplus to the monopoly. Chapter An industry with many firms, each making a differentiated product is a(n) industry. a. perfectly competitive b. monopolistically competitive c. oligopoly d. monopoly 18. When firms in an industry that is monopolistically competitive incur an economic loss, firms will a. enter the industry, and demand will increase for the original firms. b. exit the industry, and demand will increase for the remaining firms. c. exit the industry, and demand will decrease for the remaining firms. d. enter the industry, and demand will decrease for the original firms. 19. In the dominant firm model of oligopoly, the dominant firm acts as if it was a a. perfect competitor. b. monopolistic competitor. c. oligopoly. d. monopoly 20. The cooperative strategy in the prisoners dilemma game would cause a. both players to win. b. both players to lose. c. the first player to take an action to win. d. the last player to take an action to win.

5 FIRMS AND MARKETS 243 Answers Reading Between the Lines 1. The only manufacturers of the latest video game players are Sony, Microsoft, and Nintendo. Because this market has only a few firms, it is an oligopoly. 2. In setting the prices of their products, Sony and Microsoft are competing in a prisoners dilemma game. Both firms profits would be substantially higher if both kept the price at $299 rather than lowering it to $199. And, both firms profits would be lower if they both set a price of $199. However, if only one firm dropped its price to $199 while the other kept its price high, the firm lowering its price would gain a substantial increase in its market share and with it a huge profit. However, the firm with the higher price would make a much smaller profit; indeed, it likely would incur an economic loss. In this sort of prisoners dilemma game, the Nash equilibrium is for both firms to charge the lower price and earn the lower profit. The Nash equilibrium, with its lower price and lower profit, is exactly what happened in this case! 3. Sony, faced with potential competition from Microsoft, might have played a sequential game in which it set a limit price. In particular, Sony was in the market supplying video game players well before Microsoft entered. In order to deter Microsoft from entering, Sony could have set a lower price than otherwise. For instance, Sony might have set a limit price, which is a price set at the highest level that would inflict a loss on Microsoft. By setting the highest price that inflicts a loss on Microsoft, Sony s profit would have been as high as possible while also keeping Microsoft from entering. And by inflicting a loss on Microsoft, Sony could hope to keep Microsoft from entering the market. It seems likely that Sonly was not playing this sort of game for two reasons. First, Microsoft indeed did enter the market. (So if Sony was playing this game, Sony misjudged the price it should set.) Second, even immediately before Microsoft entered, Sony kept the price of its PlayStation 2 at a relatively high level, $299. Mid-Term Exam Answers 11. d; 12. a; 13. c; 14. b 15. b; 16. a; 17. c; 18. a; 19. b; 10. c; 11. c; 12. d; 13. a; 14. a; 15. b; 16. d; 17. b; 18. b; 19. d; 20. a.

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