PRACTICE PROBLEM SET 3 SOLUTIONS

Problem 1
Two soap producers, the Fortnum Company and the Maison Company, can stress either
newspapers or magazines in their forthcoming advertising campaigns. The payoff matrix is as
follows:
Manison
Company
Stress Stress
newspapers magazines
Maison's Maison's
profit: $9 profit: $8
million million

Fortnum's Fortnum's
Stress profit: $8 profit: $7
newspapers million million
Maison's Maison's
Fortnum Stress profit: $8 profit: $7
Company magazines million million
Fortnum's Fortnum's
profit: $9 profit: $8
million million

a. Is there a dominant strategy for each firm? If so, what is it?

The dominant strategy for Maison is newspapers. The dominant strategy for Fortnum is
magazines.

b. What will be the profit of each firm?

Maison’s profit will be $8 million. Fortnum’s profit will be $9 million.

c. Is this game an example of the prisoner’s dilemma?

Problem 2
The Ulysses Corporation and the Xenophon Company are the only producers of a very
sophisticated type of camera. They each can engage in either a high or low level of advertising in
trade journals. The payoff matrix is as follows:
 Xenophon
Company
Low level High level
Xenophon's Xenophon's
profit: $13 profit: $12
million million
Ulysses's Ulysses's
profit: $12 profit: $11
Low level million million
Xenophon's Xenophon's
Ulysses profit: $12 profit: $11
Corporation High level million million
Ulysses's Ulysses's
profit: $13 profit: $12
million million

a. Will Ulysses engage in a high or a low level of advertising in trade journals?

Since Ulysses’s profits are higher if it advertises at a high rather than at a low level
regardless of what Xenophon does, it will advertise at the high level.

b. Will Xenophon engage in a high or a low level of advertising in trade journals?

Since Xenophon’s profits are higher if it advertises at a low rather than at a high level
regardless of what Ulysses does, it will advertise at the low level.

c. Is there a dominant strategy for each firm?

As mentioned in parts (a) and (b), both players have a dominant strategy.

Problem 3
Two soft producers, York Cola and Reno’s Cola, secretly collude to fix prices. Each firm must
decide whether to abide by the agreement or cheat on it. The payoff matrix is as follows:

York Cola
 Abide by
agreement Cheat
York's York's
profit: $29 profit: $30
million million
Reno's
Abide by Reno's profit: profit: $26
agreement $29 million million
York's York's
profit: $26 profit: $28
Reno Cola Cheat million million
Reno's
Reno's profit: profit: $28
$30 million million

a. What strategy will each firm choose, and what will be each firm’s profit?

Reno and York each have cheat as their dominant strategy, so they will each earn $28
million.

b. Does it matter whether this agreement is for one period or for 2.5 periods?

Since abiding by the agreement would raise their profits to $29 million each if this game
were to be played out an infinite number of times, the dominant strategy would be for both to
abide if they thought that a defection would be met with cheating by their opponents in all
future rounds.

c. Is this game an example of the prisoner’s dilemma?

Yes, this is a prisoner’s dilemma since the firms are stuck in an outcome from which both
could be made better off by cooperation.

Problem 4
Two rival bookstores are trying to locate in one of two locations. The locations are near to each
other. Each would like to avoid a bidding war against one another since that will drive up each of
their rents. Payoffs are given in the following table:
Borders
 Location 1 Location 2
Barnes and Location 1 10, 10 60,40
Nobles Location 2 25, 55 20, 20

Does either player have an incentive to bid higher for a location, and if so, by how much?

Neither store has a dominant strategy in this game. Therefore, they have no incentive to bid for a
location. When one firm makes a choice, the other firm’s best strategy is to choose the other
location.

Problem 5
Consider a father who is trying to discipline his child. The father insists the child must go with
the rest of the family to visit their grandmother. The child prefers to go to a movies with a friend.
The father threatens to punish the child if the child doesn’t visit the grandmother. If the child
goes with the family to visit the grandmother, both the child and the father receive I unit of
utility. If the child refuses to go to granny’s house, and the father punishes the child, the child
receives -1, and the father receives -1 units of utility. If the child refuses to go and the father
relents (does not punish) the child receives 2 units of utility, and the father receives 0.
a. Draw the game in matrix form.

Father
Not Punish Punish
Go Child = 1
Child Father = 1
Not go Child = 2 Child = -1
Father = 0 Father = -1

b. Draw the game in extensive form.

c. Solve the game via backward induction.

Via backward induction, the child maximizes by not going. Given that the child doesn’t go,
the father maximizes (in this single-period game) by not punishing.
 PRACTICE PROBLEMS 2 SOLUTIONS

Problem 1
The Bergen Company and the Gutenberg Company are the only two firms that produce and sell a
particular kind of machinery. The demand curve for their product is

P = 580 – 3Q

where P is the price (in dollars) of the product, and Q is the total amount demanded. The total
cost function of the Bergen Company is

TCB = 410QB

where TCB is its total cost (in dollars) and QB is its output. The total cost function of the
Gutenberg Company is

TCG = 460QG

where TCG is its total cost (in dollars) and QG is its output.

a. Is these two firms collude and they want to maximize their combined profit, how much will
the Bergen Company produce?

Bergen’s marginal cost is always less than Gutenberg’s marginal cost. There Bergen would
produce all the combination’s output. Setting Bergen’s marginal cost equal to the marginal
revenue derived from the demand function yields
410 = 580 - 6Q (1)
QB = 170/6 and QG = 0

b. How much will the Gutenberg Company produce?

As discussed in part (a), Gutenberg’s marginal cost is always greater than Bergen’s. If
Gutenberg were to produce 1 unit and Bergen 1 unit less, it would reduce their combined
profits by the difference in their marginal costs. If Gutenberg were to produce 1 unit without
any reduction in Bergen’s output, it would reduce their combined profits by the same
amount.
c. Will the Gutenberg Company agree to such an arrangement? Why or not?

Without cooperation, it’s a Bertrand outcome, so only Bergen would produce and hence set
P equal to MC of the other firm. Solving this gives profit for Bergen to be 2000. With
cooperation, the total profit is $2408.33. So the difference is the maximum that Bergen would
be willing to pay.

Problem 2
The can industry is composed of two firms. Suppose that the demand curve for cans is

P = 100 – Q

where P is the price (in cents) of a can and Q is the quantity demanded (in millions per month) of
cans. Suppose the total cost function of each firm is

TC = 2 + 15q

where TC is total cost (in tens of thousands of dollars) per month and q is the quantity produced
(in millions) per month by the firm.

a. What are the price and output if managers set price equal to marginal cost?

If managers set price equal to marginal cost

For both firms, P = 100 - Q = 100 - qa - qb = MC = 15
qa = 85 – qb
By symmetry, qa = qb = 42.5
Which lead to Q = 85, P = 15 and a combined loss of 4.

b. What are the profit-maximizing price and output if the managers collude and act like a
monopolist?

If managers collude and act like a monopolist

Setting MR = MC
Solving, we get Q = 42.5 and P = 57.5
Hence, profit for the combined firm is 1804.25
Thus, managers make a higher combined profit on colluding. The profits are higher by
1804.25 - (-4) = 1808.25
c. Do the managers make a higher combined profit if they collude than if they set price equal to
marginal cost? If so, how much higher is the combined profit?

The managers make a higher combined profit if they collude than if they set price equal to
marginal cost.

Problem 3
Two firms, the Alliance Company and the Bangor Corporation, produce vision systems. The
demand curve for vision systems is

P = 200,000 – 6(Q1 + Q2)

where P is the price (in dollars) of a vision system, Q1 is the number of vision systems produced
and sold per month by Alliance, and Q2 is the number of vision systems produced and sold per
month by Bangor. Alliance’s total cost (in dollars) is

TC1 = 8,000Q1

Bangor’s total cost (in dollars) is

TC2 = 12,000Q2

a. If managers at these two firms set their own output levels to maximize profit, assuming that
managers at the other firm hold constant their output, what is the equilibrium price?

P = $73.888.34 (derived in part b).

b. What is the output of each firm?

Alliance and Bangor’s profits cab be written as

Π1 = [200000 - 6(Q1 - Q2)] Q1 - 8000Q1 = 192000Q1 - 6Q12 - 6Q1Q2
Π2 = [200000 - 6(Q1 - Q2)] Q2 - 8000Q2 = 188000Q2 - 6Q22 - 6Q1Q2

Profit-maximizing levels of output are determined by setting the first derivative of each firm’s
profit function equal to zero and solving for Q1 and Q2.
δΠ1 / δQ1 = 192000 - 12Q1 - 6Q2 = 0
δΠ2 / δQ2 = 188000 - 6Q1 - 12Q2 = 0

Solving these two equations, we get

 Q1 = 10888.89 and Q2 = 10222.22
P = 200000 - 6(10888.89 – 10222.22) = $73333.34

c. How much profit do managers at each firm earn?

At these prices and quantities, the profit will be

Π1 = 192000 Q1 - 6Q12 - 6 Q1Q2 = $711,407,550
Π2 = 188000 Q2 - 6Q22 - 6 Q1Q2 = $626,962,890

Problem 4
The West Chester Corporation believes that the demand curve for its product is

P = 28 – 0.14Q

where P is price (in dollars) and Q is output (in thousands of units). The firm’s board of
directors, after a lengthy meeting, concludes that the firm should attempt, at least for a while, to
increase its total revenue, even if this means lower profit.

a. Why might managers adopt such a policy?

b. What price should managers set if they want to maximize total revenue?

Maximize total revenue

Total Revenue (R) = 28Q – 0.14Q2
δR / δQ = 28 - 0.28Q = 0
Hence, P = 14, Q = 100

c. If the firm’s marginal cost equals $14, do managers produce a larger or smaller output than
they would to maximize profit? How much larger or smaller?

MC is 14
For maximizing profit,
MR = MC
28 – 0.28Q = 14
P = 14, Q = 50
Managers reduce output by 50 to maximize profits.
 PRACTICE PROBLEM SET 1 SOLUTIONS

Problem 1
Faced with a reputation for producing automobiles with poor repair records, a number of
American companies have offered extensive guarantees to car purchasers (e.g., a seven year
warranty on all parts and labor associated with mechanical problems.

a. In light of your knowledge of the lemons market, why is this a reasonable policy?

In the past, customers perceived American automobiles to be of low quality. To reverse this
trend, American companies invested in quality control, improving the reliability and
decreasing the repair and maintenance needs of the cars they produced. In order to signal the
quality improvement in their products, they offered longer warranties.

b. Is this policy likely to create a moral hazard problem?

Moral hazard occurs when the party to be insured (in this case, the owner of an American car
with a seven year warranty) can influence the probability or the magnitude of the event that
triggers payment (the repair of the automobile). If the manufacturer covers all parts and
labor associated with mechanical problems, the owner has lower incentive to drive carefully
or maintain the automobile. Hence, a moral hazard problem is created with extensive
warranties.

Problem 2
An insurance company is considering issuing three types of fire insurance policies:
i. Complete insurance coverage
ii. Complete coverage above and beyond a $10,000 deductible
iii. 90 percent coverage of all losses
Which policy is more likely to create moral hazard problems?

Moral hazard problems arise with fire insurance when the insured party can influence the
probability of a fire. The property owner can reduce the probability of a fire or its impact by
inspecting and replacing faculty wiring, installing warning systems, etc. After purchasing
complete insurance, the insured has little incentive to rescue either the probability or the
magnitude of the loss, so the moral hazard problem can be severe. In order to compare a $10,000
deductible and 90 percent coverage, we need information on the value of the potential loss. Both
policies reduce the moral hazard problem of complete coverage. However, if the property is
worth less (more) than $100,000, the total loss will be less (more) with 90 present coverage than
with the $10,000 deductible. As the value of the property increases above $100,000, the owner is
more likely to engage in fire prevention efforts under the policy that offers 90 percent coverage
than under the one that offers the $10,000 deductible.

Problem 3
You have seen how asymmetric information can reduce the average quality of products sold in a
market, as low-quality products drive out high-quality products. For those markets in which
asymmetric information is prevalent, would you agree or disagree with each of the following?
Explain briefly:
a. The government should subsidize Consumer Reports.

Agree. Removes asymmetry in information, prevents market breakdown.

b. The government should impose quality standards – e.g., firms should not be allowed to sell
low-quality products.

Agree. Quality standards send out credible signal.

c. The producer of high-quality good will probably try to offer extensive warranty.

Agree. Provided the competitor does not match it.

d. The government should require all firms to offer extensive warranties.

Agree. Low Quality producers will leave the market.

 ASSIGNMENT SUBMISSION FORM

Course Name: Managerial Economics

Assignment Title: Homework 4, DHM 1

Submitted by: Study Group C08: Co’22

Student Name PG ID

Hajra Anwer 62110644

Puspendu Ghosh 62110051

Rushabhdev Shah 62110942

Saipraneeth Swayampakula 62110997

Sangeetha Padmanabhan 62110627

ISB Honour Code

• I will represent myself in a truthful manner.

• I will not fabricate or plagiarise any information with regard to the curriculum.
• I will not seek, receive or obtain an unfair advantage over other students.
• I will not be a party to any violation of the ISB Honour Code.
• I will personally uphold and abide, in theory and practice, the values, purpose and rules of
the ISB Honour Code.
• I will report all violations of the ISB Honour Code by members of the ISB community.
• I will respect the rights and property of all in the ISB community.
• I will abide by all the rules and regulations that are prescribed by ISB.
Problem 1 : An old lady is looking for help crossing the street.1 Only one person is needed to
help her; more are okay but no better that one. Sunny and Simran are the two people in the
vicinity who can help; each has to choose simultaneously whether to do so. Each of the two
will get utility worth 3 from the old lady’s success (no matter who helps her). But each one
who goes to help will bear a cost of 1, this being the utility value of the person’s time taken
up in helping. Set this up as a game. Write the payoff table, and find all pure-strategy Nash
equilibria
Solution:
In this Simultaneous Game
Given Players : Sunny , Simran
Existing strategies : ( Help , Don’t help )
Utilities : 3 for the old lady’s success
Cost of utility (of the person helping) : 1
Therefore, outcomes of 4 combinations of strategies “Help” and “Don’t help” of 2 players
SIMRAN
Help Don’t help
SUNNY Help 2,2 2,3
Don’t help 3,2 0,0

PAYOFF TABLE

Let’s calculate best payoff to arrive at the Nash Equilibria. Assume horizontal line represents
the Payoff for Sunny and vertical Line represents the Simran.
Analysing Sunny’s Payoff :
If Sunny chooses the strategy “Help”, Simran will have a choice between a payoff of 2 and 3.
Simran will choose higher payoff of 3 which corresponds to the strategy “Don’t Help”.
If Sunny chooses the strategy “Don’t help”, Simran will have a choice between a payoff of 2
and 0. Simran will choose higher payoff of 2 which corresponds to the strategy “Help”.
The strategy Matrix looks like Following :

SIMRAN
Help Don’t help
SUNNY Help 2,2 2,3
Don’t help 3,2 0,0
Similarly, Simran’s Payoff :
If Simran chooses the strategy “Help”, Sunny will have a choice between a payoff of 2 and
3. Sunny will choose higher payoff of 3 which corresponds to the strategy “Don’t Help”.
If Simran chooses the strategy “Don’t Help”, Sunny will have a choice between a payoff of 2
and 0. Sunny will choose higher payoff of 2 which corresponds to the strategy “Help”.

SIMRAN
Help Don’t help
SUNNY Help 2,2 2,3
Don’t help 3,2 0,0

Finally, the best response output from above table is Multiple Nash Equilibria with two
Nash equilibrium Pairs (2,3) and (3,2) which corresponds to the below strategies-
(2,3) : ( Sunny : Help and Simran : Don’t Help)
(3,2) : ( Sunny : Don’t Help and Simran : Help)
Problem 2 (10 points) Having muscled out the other bhelpuri vendors on Chowpatty Beach in
Bombay, the proprietors of Royal Bhelpuri and Modern Bhelpuri have to decide where to
locate their stalls. Customers are situated uniformly along the beach, and will purchase 1 bhel
from the vendor closest to them. a. (5 points) If the beach is 1 km long, what are the Nash
equilibrium locations for Royal and Modern? b. (5 points) If a new entrant, Tasty Bhelpuri,
enters the market, what are the equilibrium locations?

Solution-
Notations –
(i) Royal Bhelpuri – R and Modern Bhelpuri – M
(ii) Total customers on the beach - P
(a)
Let’s start by assuming that the vendors, Royal and Modern start from the Socially Optimal
Solution, i.e. as shown in Figure 1 both are located 250 metres from the either ends of the 1
km long beach.
In this case, the total customer base will be divided equally between both the vendors and
also the customers have to travel less to reach the vendor. But, let’s check if this is the Nash
Equilibrium.

P/4 P/4 P/4 P/4

R M

250 m 250 m
Figure 1

Now to increase his customer base, R will be incentivized to move towards the right (As in
Figure 2). Simultaneously, M will also move towards left to increase his customer base
(Figure 3)

P/4 + x (P/4 – x/2) (P/4 – x/2) P/4

R M

Figure 2

(P/4 – x/2 -y/2) (P/4 – x/2- y/2) P/4 + y

P/4 + x

R M

Figure 3
However, once they reach the centre of the beach, none of them will be incentivized to move
further because it will reduce their customer base. Refer Figure 4.

Midpoint of the beach

P/4 P/4
R

P/4 M P/4

Figure 4

Hence, Nash equilibrium location both Royal and Modern Bhelpuri is at the midpoint of
the 1 km beach.

(b) If new entrant Tasty Bhelpuri (say T) enters the market,

Let’s start from Nash equilibrium positions of two vendor beach (from previous part) and a
new vendor T enters , refer Figure 5
At this location of all three vendors (Figure 5), all the vendors will get an equal customer
base of P/3

P/6 P/6

T
P/6 P/6
R

P/6 M P/6

Figure 5
Now, one of the vendors (say T) moves to the right by a distance say x = 1/10 km to increase
his customer base. Then customer base will get distributed as-
T = (P/2 – P/10) + P/20 = 9P/20 = 45% P
R = P/4 + P/40 = 11P/40 = 27.5% P
M = P/4 + P/40 = 11P/40 = 27.5% P

P/4 R X/4
X/2 P/2 - X
T
X = 1/10
P/4 M X/4

Figure 6

R
T
M

Figure 7

Since with the movement the customer base of T has increased from 33.33% P (P/3) to 45%
P, simultaneously other players will also be motivated to the same and move towards right.
However, once all move towards right, a vendor (Say T) can move to left and increase its
customer share, refer Figure 7. This will go on and on repeatedly and NO Nash Equilibrium
will be arrived at.
Problem 3 (5 points)
Find the Cournot-Nash Equilibrium in a game with two French fry manufacturers, Freddie’s
Fries and Charlie’s Chips. There are five levels of production: produce 6,8, or 12 million tons
of output. The numbers in the table below represent as (FF,CC) the profits for Freddie’s Fries
and Charlie’s Chips corresponding to the quantities they produce.
6 8 12
6 18,18 15,20 9,10
8 20,15 16,16 8,12
12 18,9 12,8 0,0

Solution:
Let us say the horizontal line represents the profit for Charlie’s Chips (CC) and vertical line
represents the profit for Freddie’s Fries (FF).
Charlie’s Chips (CC)
Production 6 8 12
Freddie’s (mil)
Fries 6 18,18 15,20 9,10
(FF) 8 20,15 16,16 8,12
12 18,9 12,8 0,0

If CC chooses 6, FF will have a choice between 18,20,18 and choose 20 (production 8) as its
strategy as it gives the highest profit.
If CC chooses 8, FF will have a choice between 15,16,12 and choose 16 (production 8) as its
strategy.
If CC chooses 12, FF will have a choice between 9,8,0 and choose 9 (production 6) as its
strategy.
The strategy matrix would look like following:
Charlie’s Chips (CC)
Production 6 8 12
Freddie’s (mil)
Fries 6 18,18 15,20 9,10
(FF) 8 20,15 16,16 8,12
12 18,9 12,8 0,0

Simultaneously,
If FF chooses 6, CC will have a choice between 18,20,10 and choose 20 (production 8) as its
strategy as it gives the highest profit.
If FF chooses 8, CC will have a choice between 15,16,12 and choose 16 (production 8) as its
strategy.
If FF chooses 12, CC will have a choice between 9,8,0 and choose 9 (production 6) as its
strategy.
The strategy matrix would look like the following:
Charlie’s Chips (CC)
Production 6 8 12
Freddie’s (mil)
Fries 6 18,18 15, 20 9,10
(FF) 8 20,15 16, 16 8,12
12 18,9 12,8 0,0

So, the best response output and Cournot-Nash equilibrium in this game is 16,16 which
corresponds to the strategy that “FF and CC both produce 8 million tons of output” as
it gives the highest payoff for both the players.
Problem 4

Consider a Cournot duopoly in which the two firms have different marginal costs. The
inverse demand in the market is P(Q) = 15 – Q. The costs of firm A and firm B are CA(qA) =
6qA and CB(qB) = 3qB, respectively.

1. (3 points) What is the best response (or reaction) function of firm A?

2. (3 points) What is the best response (or reaction) function of firm B?
3. (3 points) What are the equilibrium quantities produced by each firm?
4. (2 points) What is the market price?
5. (2 points) What are the profits of each firm?

1)
For firm A:
Total Revenue = P * qA = (15 – qA – qB ) * qA

Marginal Revenue = d TR/ d qA = 15 - 2 qA – qB

Marginal Cost = d CA(qA)/d qA = 6
Equating MR = MC,
15 - 2 qA – qB = 6
 2 qA = 9 – qB

2)
For firm B:
Total Revenue = P * qB = (15 – qA – qB) * qA

Marginal Revenue = d TR/ d qB = 15 - 2 qB – qA

Marginal Cost = d CA(qB)/d qB = 3
Equating MR = MC,
15 - 2 qB – qA = 3
 2 qB = 12 - qA

3)
Solving two equations for equilibrium quantities =>
9 - qB = 2 qA
Substituting value of qA from response function of B –
9 – qB = 2(12 - 2 qB)
9 – qB = 24 - 4 qB
3 qB = 15
qB = 5

Therefore, qA = 12 – 2(5) = 2
 Equilibrium quantities : qA = 2 and qB = 5

4) Market quantity is given by - Q = qA + qB = 5 + 2 = 7

Market price is given by – P(Q) = 15 – Q
Substituting for Q : P(7) = 15 – 7 = 8

 Market price = 8

Firm A Firm B
4.5
4
3.5
3
2.5
qA

2
1.5
1
0.5
0
0 1 2 3 4 5 6 7 8
qB

5) Profits for each firm = Revenue – Cost

Profit for Firm A = P* qA - CA(qA) = P qA - 6 qA = 8 qA - 6 qA = 2 qA = 2* 2 = 4
Profit for Firm B = P* qB - CB(qB) = P qB - 3 qB = 8 qB - 3 qB = 5 qB = 5*5 = 25
Problem 5 (8 points) The accompanying article presents a decision facing Robert Gates, the
US Secretary of Defense, who is trying to reduce costs for the US Air Force’s F-35 fighter
program. The engines for the plane are currently produced by Pratt and Whitney in
Connecticut. Some lawmakers want to start a second production line for the engines in Ohio,
run by GE and Rolls Royce. Mr. Gates argues that a single production line will save costs for
the military, while Ohio lawmakers (who value the jobs the second line will create) say that
competition will lower engine prices and increase the welfare accruing to the sole consumer –
the US military. As a budget analyst at the Pentagon, you have been asked to analyze two
possible scenarios and advise Secretary Gates on production strategy. You determine that the
military’s demand curve for F-35 engines is given by P=1000-Q. The marginal cost of
production (revealed in Congressional filings) is $120 mm per additional plane for Pratt and
Whitney (the original incumbent) and $160 mm per additional plane for GE-Rolls Royce (the
potential entrant).
a. (1+1+1 = 3 points) What is the quantity of engines produced if Pratt and Whitney is the
monopolist supplier in the market? What is the price that the government has to pay for the
engines? What is the consumer surplus for the military in this case?
b. (2+1+2 = 3 points) Now consider the duopoly case where Pratt and Whitney is the
Stackelberg leader and GE-Rolls Royce is the Stackelberg follower. What is the price that the
government has to pay for the engines? How many engines are produced and what is the
consumer surplus for the military in this case?
c. (2 points) Should Secretary Gates agree to the second production line? Explain briefly.

Solution-
a) Since it is a monopoly and Demand Curve : P=1000-Q
TR(PW) = (1000 - QPW) x QPW
MR(PW) = 1000-2Q(PW) = MC(PW) = 120

Which means (MR=MC) for profit maximization

Q(PW) will be 440
Thereafter
P(PW) = 1000 - 440 = 560 million

Hence total amount to be paid will be = 440 x 560 = 246.4 billion

Consumer surplus = 0.5 x 440 x ( 1000 – 560 ) = 96800 million
b) Since is it a Stackelberg case in which Pratt and Whitney (PW) is the leader

Given P = 1000 - Q(PW) - Q(GE)

TR(GE) = (1000 - Q(PW) - Q(GE) x Q(GE)

MR(GE) = 1000 - Q(PW) - 2Q(GE) = MC(GE) = 160

Which means for profit maximization

Q(GE) = 420 - Q(PE) / 2

Thereafter

P(PW) = 1000 - Q(PW) - 420 + (Q(PW)/2)

580 - Q(PW)/2

TR(PW) = 580Q(PW) - QPW2/2

MR(PW) = 580 - Q(PW) = MC(PW) = 120

Hence Q(PW) = 460 & therefore Q(GE) will be = 190

Therefore total Q* = 460 + 190 = 650

P* = 1000-650 = 350

Aggregate sum to be finally paid = 650 * 350 = 227500 million

And subsequently consumer surplus will be calculated as = 0.5 x 650 ( 1000 - 350 ) =
211250 million
c)Since it is a monopoly

Price per engine Total expenditure - Military Consumer Surplus

560 $246,400 million $96,800 million

Since there are two production lines

Price per engine Total expenditure - Military Consumer Surplus

350 $227,500 million $211,250 million

As the price per engine and total expenditure for the military dips lower and consumer
surplus rises, therefore the subsequent creation line is advantageous to the military and
Gates should consent to it.