Module M08 Quiz: Game Theory and Oligopoly
25 questions · Introductory · Mix of multiple choice, calculation, and short answer
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Attempt each question before clicking Show Answer. For calculation questions, write out your working first.
Question 1
Lesson L01 · Game Theory
In game theory a 'dominant strategy' is:
Type: Multiple Choice
- A) The strategy that always beats every other strategy regardless of what rivals do
- B) The strategy chosen by the largest firm
- C) The strategy that maximises industry profit
- D) Any strategy chosen in equilibrium
Show Answer
Answer: A) The strategy that always beats every other strategy regardless of what rivals do
A dominant strategy is optimal regardless of what opponents choose — it doesn't depend on their actions.
Question 2
Lesson L01 · Game Theory
Coles and Woolworths each choose between High price and Low price. If Low price is a dominant strategy for both, what is the Nash equilibrium?
Type: Multiple Choice
- A) Both choose High
- B) Both choose Low
- C) Coles chooses High, Woolworths chooses Low
- D) No equilibrium exists
Show Answer
Answer: B) Both choose Low
When both firms have Low as dominant strategy, (Low, Low) is the Nash equilibrium — neither wants to deviate unilaterally.
Question 3
Lesson L01 · Game Theory
In a 2-player simultaneous game Firm A earns $4m if both advertise, $6m if only A advertises, $1m if only B advertises, $3m if neither advertises. What is Firm A's dominant strategy?
Type: Calculation
Show Answer
Answer: Advertise
If B advertises: A earns $4m (advertise) vs $1m (don't) → advertise. If B doesn't: A earns $6m (advertise) vs $3m (don't) → advertise. Advertise dominates.
Question 4
Lesson L01 · Game Theory
Explain the concept of a Nash Equilibrium in plain language.
Type: Short Answer
Show Answer
Answer: A Nash Equilibrium is a set of strategies where no player can improve their outcome by changing their own strategy, given what all other players are doing. Everyone is playing their best response to everyone else.
At Nash Equilibrium, each player's strategy is optimal given the strategies of all other players.
Question 5
Lesson L01 · Game Theory
Which real-world situation is best modelled as a simultaneous game?
Type: Multiple Choice
- A) A firm deciding its price after observing a rival's price
- B) Two firms simultaneously setting prices without knowing each other's choice
- C) A firm deciding whether to enter a market after an incumbent has already invested
- D) A worker negotiating a wage with their employer
Show Answer
Answer: B) Two firms simultaneously setting prices without knowing each other's choice
Simultaneous games model decisions made without knowledge of rivals' choices — common in pricing, advertising, and R&D races.
Question 6
Lesson L02 · Game Theory
In the classic Prisoners' Dilemma both prisoners confess even though both would be better off staying silent. This happens because:
Type: Multiple Choice
- A) They are irrational
- B) Confess is a dominant strategy for each prisoner individually even though mutual silence gives a better collective outcome
- C) The police force them to confess
- D) They don't know the payoffs
Show Answer
Answer: B) Confess is a dominant strategy for each prisoner individually even though mutual silence gives a better collective outcome
Confess dominates silence for each prisoner individually — the individually rational outcome is collectively suboptimal.
Question 7
Lesson L02 · Game Theory
Two firms in a Prisoners' Dilemma each earn $5m if they collude, $2m each if both defect, \(8m for the defector/\)1m for the cooperator. What is the Nash equilibrium payoff for each firm?
Type: Calculation
Show Answer
Answer: $2m each
Both firms defect (dominant strategy) → each earns \(2m — the Nash equilibrium despite the fact that mutual cooperation (\)5m each) is better.
Question 8
Lesson L03 · Game Theory
Which feature of oligopoly markets makes game theory essential?
Type: Multiple Choice
- A) Many small firms
- B) Strategic interdependence — each firm's profit depends on rivals' decisions
- C) Perfect information
- D) Free entry and exit
Show Answer
Answer: B) Strategic interdependence — each firm's profit depends on rivals' decisions
Oligopolists must consider how rivals will react to their decisions — classic strategic interdependence modelled by game theory.
Question 9
Lesson L02 · Game Theory
Why does repetition of the Prisoners' Dilemma make cooperation more likely?
Type: Short Answer
Show Answer
Answer: In a repeated game players can use tit-for-tat strategies — cooperate if the other cooperated last period, defect if they defected. The threat of future punishment makes defection less attractive when both parties value the ongoing relationship.
Cooperation can be sustained if the future payoff from cooperation exceeds the one-time gain from defecting.
Question 10
Lesson L02 · Game Theory
ACCC leniency policy encourages cartel members to report the cartel by offering immunity from prosecution. How does this affect cartel stability?
Type: Multiple Choice
- A) It strengthens cartels by clarifying rules
- B) It destabilises cartels by making defection (reporting) more attractive — turning the cartel into a Prisoners' Dilemma
- C) It has no effect on cartel stability
- D) It makes cartels more profitable
Show Answer
Answer: B) It destabilises cartels by making defection (reporting) more attractive — turning the cartel into a Prisoners' Dilemma
Leniency creates a race to report: each member fears a rival will report first, so the dominant strategy shifts toward defecting (reporting), destabilising the cartel.
Question 11
Lesson L03 · Game Theory
Australia's banking sector is dominated by the Big Four (CBA, NAB, ANZ, Westpac). This is an example of:
Type: Multiple Choice
- A) Perfect competition
- B) Monopoly
- C) Oligopoly
- D) Monopolistic competition
Show Answer
Answer: C) Oligopoly
A market with a small number of large firms with strategic interdependence is an oligopoly.
Question 12
Lesson L03 · Game Theory
The kinked demand curve model predicts price rigidity in oligopoly because:
Type: Multiple Choice
- A) Firms always collude on price
- B) If a firm raises price rivals don't follow (so it loses customers) but if it cuts price rivals match (so it gains little) — demand is elastic above and inelastic below the current price
- C) Government regulations prevent price changes
- D) Oligopolists always charge MC
Show Answer
Answer: B) If a firm raises price rivals don't follow (so it loses customers) but if it cuts price rivals match (so it gains little) — demand is elastic above and inelastic below the current price
The asymmetric response creates a kink at the current price — the firm has little incentive to change price in either direction.
Question 13
Lesson L03 · Game Theory
If an oligopolist in a kinked demand market has MC=\(20 and the kink is at P=\)50, what happens to price if MC rises to $35?
Type: Calculation
Show Answer
Answer: Price stays at $50
The MR curve has a gap at the kink. If MC stays within this gap price is unchanged. MC rising from $20 to $35 (still within the gap) leaves price rigid at $50.
Question 14
Lesson L03 · Game Theory
Why might tacit collusion be more stable in a market with few, transparent firms?
Type: Short Answer
Show Answer
Answer: With few firms it is easier to detect cheating on an implicit agreement. Price transparency means deviations are quickly observed and can be punished (e.g. price war), making the expected cost of defection high.
Monitoring and punishment are easier with fewer players and observable prices.
Question 15
Lesson L03 · Game Theory
Which Australian industry has been found by the ACCC to have engaged in price-fixing cartel conduct?
Type: Multiple Choice
- A) Wool farming
- B) Visy/Amcor in the cardboard packaging industry
- C) The NBN
- D) Small supermarkets
Show Answer
Answer: B) Visy/Amcor in the cardboard packaging industry
The ACCC prosecuted Visy and Amcor for a decade-long cardboard packaging cartel — one of Australia's most significant cartel cases.
Question 16
Lesson L04 · Game Theory
Price-fixing between competitors is:
Type: Multiple Choice
- A) Legal if prices stay below the CPI
- B) Illegal in Australia under the Competition and Consumer Act 2010
- C) Only illegal for public companies
- D) Legal if approved by the ACCC
Show Answer
Answer: B) Illegal in Australia under the Competition and Consumer Act 2010
Cartel conduct including price-fixing is a criminal offence in Australia under the CCA 2010 with penalties up to 10 years imprisonment and $50m fines.
Question 17
Lesson L04 · Game Theory
Two airlines secretly agree to charge $400 for Sydney-Melbourne. Without the agreement each would charge $300. If market demand at $400 is 500 passengers per flight, estimate combined cartel profit premium vs competitive baseline.
Type: Calculation
Show Answer
Answer: $50,000 per flight
Extra revenue per flight = (\(400-\)300)×500=$50,000. This is the transfer from consumers to the cartel (before cost considerations).
Question 18
Lesson L04 · Game Theory
Why is a cartel inherently unstable even without regulatory intervention?
Type: Short Answer
Show Answer
Answer: Each cartel member has an individual incentive to cheat by cutting price slightly below the agreed level to steal customers. Since all members face this incentive, the cartel tends to collapse — a classic Prisoners' Dilemma.
The cooperative outcome is not a Nash equilibrium: each member prefers to defect given others' cooperation.
Question 19
Lesson L04 · Game Theory
Which ACCC policy makes it easier to prosecute cartels by incentivising members to provide evidence?
Type: Multiple Choice
- A) Merger authorisation
- B) Leniency policy (immunity for the first member to report the cartel)
- C) Access regulation
- D) Market study powers
Show Answer
Answer: B) Leniency policy (immunity for the first member to report the cartel)
The ACCC's immunity/leniency policy offers the first cartel member to self-report full immunity from prosecution, destabilising cartels.
Question 20
Lesson L04 · Game Theory
Tacit collusion is harder to prosecute than explicit collusion because:
Type: Multiple Choice
- A) It is legal under Australian law
- B) There is no direct communication or agreement to prove — firms independently arrive at similar strategies
- C) It only occurs in competitive markets
- D) The ACCC lacks jurisdiction over tacit collusion
Show Answer
Answer: B) There is no direct communication or agreement to prove — firms independently arrive at similar strategies
Tacit collusion involves parallel pricing without explicit agreement — no smoking gun communication exists, making legal proof very difficult.
Question 21
Lesson L05 · Game Theory
In a sequential entry game the incumbent invests in large capacity before the potential entrant decides. This is an example of:
Type: Multiple Choice
- A) Nash equilibrium in simultaneous games
- B) First-mover advantage via credible commitment
- C) Tacit collusion
- D) Predatory pricing
Show Answer
Answer: B) First-mover advantage via credible commitment
By committing to high capacity first the incumbent credibly signals it will produce a lot if entry occurs, making entry unprofitable — a first-mover advantage.
Question 22
Lesson L05 · Game Theory
In backward induction what do we solve first?
Type: Multiple Choice
- A) The first decision in the game
- B) The last decision in the game
- C) All decisions simultaneously
- D) The dominant strategy
Show Answer
Answer: B) The last decision in the game
Backward induction starts at the end of the game tree and works backwards, finding optimal decisions at each node given what will happen next.
Question 23
Lesson L05 · Game Theory
Incumbent earns $10m (monopoly) or $4m (duopoly). Entrant earns $3m (enter) or $0 (stay out). If incumbent can commit to 'fight entry' earning only $2m as duopolist, does entry occur?
Type: Calculation
Show Answer
Answer: No entry
Entrant compares $3m (enter, face fight → duopoly $3m) vs $0. But if incumbent credibly commits to fight, duopoly profit for entrant may be negative. Assuming fight makes entry unprofitable → no entry.
Question 24
Lesson L05 · Game Theory
Why must a commitment device be credible to deter entry?
Type: Short Answer
Show Answer
Answer: An incredible threat (one the firm would not actually carry out after entry) will be ignored by the entrant. The commitment must change the incumbent's payoff so that fighting entry actually becomes rational ex post, not just a bluff.
Credibility requires the threat to be a best response after entry has occurred, not just before.
Question 25
Lesson L05 · Game Theory
Woolworths builds a new distribution centre before Aldi announces Australian expansion plans. This could be interpreted as:
Type: Multiple Choice
- A) Predatory pricing
- B) A commitment to cost efficiency that makes the market less attractive to Aldi
- C) Collusion with Aldi
- D) Vertical integration
Show Answer
Answer: B) A commitment to cost efficiency that makes the market less attractive to Aldi
Investing in cost-reducing capacity before a rival's entry decision can credibly signal lower costs and higher future output, deterring entry.