MicroeconomicsHomework 6.

There are ve questions in this homework, each worth 20 marks. 1. Suppose two computer rms, A and B, are planning to market network systems for oce information management. Each rm can develop either a fast, high-quality system (H), or a slower, low-quality system (L). Market research indicates that the resulting prots to each rm for the alternative strategies are given by the following payo matrix: H L

H 50, 40 60, 45 L 55, 55 15, 20 (a) Find the Nash equilibria of this game. (8) (b) Suppose now that rm A can move rst. Draw the extensive form of the game. What will be the outcome of the game? What will be the outcome if Firm B can move rst? (12) 2. BW, Exercise 19.2, Page 723. (20) 3. Suppose two rms are engaged in Cournot competition. The market demand curve is P = 100 Q1 Q2 . The total cost of rm i is T Ci = 2 + 15Qi . (3+5+7+5) (a) What are the prot maximizing output levels of the two rms if they decide on quantity independently? Find the associated prot levels. (5) (b) Now suppose the two rms collude. What is the prot maximizing output level and the associated prot? (5) (c) Suppose the two rms interact only once. Can such collusion be sustained? Why or why not? Give a precise quantitative answer. (7) (d) Suppose the two rms interact repeatedly. In this situation, can collusion be sustained? Describe in words the nature of a strategy that can sustain the collusion. (3) 4. BW, Exercise 20.4, Page 766. (Read Section 20.2 to answer this question). (20) 1

5. Suppose there are two types of workers, one high quality (H) and the other low quality (L). The H types marginal product is 5 and the low types marginal product is 2. Suppose the proportion of H type workers is 0.4. So, the proportion of L type is 0.6. (a) Assume lots of rms compete for workers. If rms know the type of a worker, what would be wages paid to a high type worker and a low type worker? (3) (b) If rms cannot tell the type of the worker, what would be the wage rate paid to a worker? (4) (c) Suppose rms cannot tell the type of the worker. Workers can now choose to acquire education to signal its type to the rms. Suppose the cost of acquiring an unit of education for the high type worker is cH = 1 and cost for the low type worker is cL = 2. cL > cH because the high type worker can work harder and so has a lesser eort cost. Assume that the minimum possible level of education is zero. How many units of education would the high type and the low type workers choose to acquire respectively in order to signal their types to rms? (Hint: Since the minimum possible level of education is zero, low ability workers in any separating equilibrium will choose to acquire zero education.) (8) (d) Would the H type workers prefer to acquire education as a signal or would they prefer not to acquire education? What would your answer be if the proportion of H type is 0.6 and the proportion of L type is 0.4? (5)