Theme 3

Question 1

What is game theory

Answer 1

A theory that firms would collude to set price and output to increase joint profit

Question 2

What is Kinked demand and the diagram

Answer 2

Demonstrates the rigidity of prices

Question 3

What is the evaluation of game theory?

Answer 3

• there is incentive to cheat the quota
• it depends on the conditions of the market if they’re suitable for collusion e.g homogenous goods, PED of good, high market share, similar business objectives
• The model is too simple as oligopolies are usually more than two firms whereas the model only shows two

Question 4

Evaluate the kinked diagram

Answer 4

• in reality price wars do happen
• firms may collude
• non price factors like quality or location can change the price
• cost can be absorbed by firms until it exceeds the vertical section.

Question 5

On a cost and revenue diagram how do you show an increase in fixed cost

Answer 5

Shift AC upwards

Question 6

How do you a show an increase in variable cost

Answer 6

Shift mc and ac

Question 7

Why may profitability not decrease despite an increase in prices

Answer 7

• cost of raw materials is volatile
• raw materials are a small % of total cost
• profit is determined by revenue
• high cost may eliminate competition and increase the firms market share
• collusion may occur in the market structure

Question 8

Why is the coffee industry a contestable market?

Answer 8

• rent is low, raw materials are cheap and skills needed is minimal
• capital can be rented instead of bought

Question 9

What is the problem of subsidies when preventing a shut down

Answer 9

• opportunity cost
• information gaps on how much and how the firms will use
• moral hazard may occur
• firms may become dependent (zombie firms)
• Policy myopia, may be effective in short and not long term
• Does not solve underlying problem e.g DEOS and lack of synergy

Question 10

why may x-inefficiency occur in a firm

Answer 10

• organisational slack
• rising cost of labour

Question 11

how do you show a rise in variable cost in cost and revenue diagram

Answer 11

increase in mc and ac