Question 3 25 marks In an hour Kim can produce 50 pies or 40

Question 3 (25 marks) In an hour, Kim can produce 50 pies or 400 cakes, and Liam can produce 150 pies or 300 cakes. If Kim and Liam spend 30 minutes of each hour producing pies and 30 minutes producing cakes, how many pies and cakes does each of them produce? a) b) Who has a comparative advantage in producing pies, and in producing cakes? c) If Kim and Liam specialise and trade, what is the highest price of a pie at which Kim and Liam would agree to trade pies and cakes? What are the gains from trade? Question 4 (25 marks) Suppose that United Airlines and American Airlines are the only air carriers that serve between New York and Boston. Each currently earns a profit of S6,000 per flight on this route. If United increases its advertising spending in this market by $1,000 per flight, and American spends no more on advertising than it does now, United\'s profit will rise to $8,000 per flight and American\'s will fall to $2,000. If both spend S1,000 more on advertising, each will earn an economic profit of S5,500 per flight. These payoffs are symmetric, so that if United spends the same amount on advertising while American increases its spending by S1,000, United\'s economic profit will fall to $2,000 per flight and American\'s will rise to S8,000 a) Develop the payoff matrix. b) Does each player have a dominant strategy? Explain c) What are the potential equilibriums? Explain d) Is this game a prisoner\'s dilemma? Explain

Solution

Solution : 3

a)

Per hour producton of pies by Kim = 50

Per hour producton of Cakes by Kim = 400

Per hour producton of pies by Liam = 150

Per hour producton of Cakes by Liam = 300

If 30 minutes spend in production of pies and 30 minutes in cakes then:

Production of Pies by Kim = 50/2 = 25

Production of Cakes by Kim = 400/2 = 200

Production of Pies by Liam = 150/2 = 75

Production of Cakes by Liam = 300/2 = 150

b:

Time requried in produciton of each unit of Pies by Kim = 60/50 = 1.20 minutes

Time required in production of each unit of cakes by Kim = 60/400 = 0.15 minutes

Time requried in produciton of each unit of Pies by Liam = 60/150 = 0.40 minutes

Time required in production of each unit of cakes by Kim = 60/300 = 0.20 minutes

Hence liam has compartive advantage in producing pies as time taken by him is lesser than time taken by Kim. Further Kim has advantage in producing cakes as time taken by him is lesser than time taken by liam.

c:

If Kim and liam specialize and trade than it means Liam should produce only pies and Kim should produce only cakes so that maximum production they can achieve and revenue should remain the same for both of them.

It means price of 150 pies should be equal to price of 400 cakes

150 Pies = 400 Cakes

Pries of pie = 2.667 of price of cake

Price of Cake = 150/400 = 0.375 of price of pie