ME Problem Set IX

PGP 2016-18
1. Two computer firms, A and B, are planning to market network systems for office
information management. Each firm can develop either a fast, high-quality system (High), or a
slower, low-quality system (Low). Market research indicates that the resulting profits to each
firm for the alternative strategies are given by the following payoff matrix:
Firm B

Firm A

High

Low

High

50, 40

60, 45

Low

55, 55

15, 20

a) If both firms make their decisions at the same time, what will the outcome be?
b) Suppose that both firms try to maximize profits, but that Firm A has a head start in
planning and can commit first. Now what will be the outcome? What will be the
outcome if Firm B has the head start in planning and can commit first?
c) Now consider the two-stage game in which, first, each firm decides how much money
to spend to speed up its planning, and, second, it announces which product (H or L) it
will produce. Which firm will spend more to speed up its planning? How much will it
spend? Should the other firm spend anything to speed up its planning? Explain.
2. Two firms are in the chocolate market. Each can choose to go for the high end of the market
(high quality) or the low end (low quality). Resulting profits are given by the following payoff
matrix:
Firm 2

Firm 1

Low

High

Low

- 20, -30

900, 600

High

100, 800

50, 50

a. What outcomes, if any, are Nash equilibria?

b. If the managers of both firms are conservative and each follows a maximin strategy,
what will be the outcome?
c. What is the cooperative outcome?
d. Which firm benefits most from the cooperative outcome? How much would that firm
need to offer the other to persuade it to collude?

3. Two major networks are competing for viewer ratings in the 8:00-9:00 P.M. and 9:00-10:00
P.M. slots on a given weeknight. Each has two shows to fill this time period and is juggling its
lineup. Each can choose to put its bigger show first or to place it second in the 9:00-10:00
P.M. slot. The combination of decisions leads to the following ratings points results:
Network 2

Network 1

First

Second

First

20, 30

18, 18

Second

15, 15

30, 10

a) Find the Nash equilibria for this game, assuming that both networks make their
decisions at the same time.
b) If each network is risk-averse and uses a maximin strategy, what will be the resulting
equilibrium?
c) What will be the equilibrium if Network 1 makes its selection first? If Network 2 goes
first?
d) Suppose the network managers meet to coordinate schedules and Network 1 promises
to schedule its big show first. Is this promise credible? What would be the likely
outcome?
4. Two competing firms are each planning to introduce a new product. Each will decide
whether to produce Product A, Product B, or Product C. They will make their choices at the
same time. The resulting payoffs are shown below.
We are given the following payoff matrix, which describes a product introduction
game:
Firm 2

Firm 1

-10, -10

0, 10

10, 20

10, 0

20, 20

5, 15

20, 10

15, 5

30, 30

a. Are there any Nash equilibria in pure strategies? If so, what are they?
b. If both firms use maximin strategies, what outcome will result?
c. If Firm 1 uses a maximin strategy and Firm 2 knows this, what will Firm 2 do?

5. We can think of U.S. and Japanese trade policies as a prisoners dilemma. The two countries
are considering policies to open or close their import markets. The payoff matrix is shown
below.
Japan

U.S.

Open

Close

Open

10, 10

5, 5

Close

-100, 5

1, 1

a. Assume that each country knows the payoff matrix and believes that the other country
will act in its own interest. Does either country have a dominant strategy? What will
be the equilibrium policies if each country acts rationally to maximize its welfare?
b. Now assume that Japan is not certain that the United States will behave rationally. In
particular, Japan is concerned that U.S. politicians may want to penalize Japan even if
that does not maximize U.S. welfare. How might this concern affect Japans choice of
strategy? How might this change the equilibrium?
6. ABC and XYZ are the only two firms selling gizmos in Europe. The following table shows
the profit (in millions of euros) that each firm earns at different prices (in euros per unit).
ABCs profit is the left number in each cell; XYZs profit is the right number.

Is there a unique Nash equilibrium in this game? If so, what is it? If not, why not? Explain
clearly how you arrive at your answer.
7. Suppose market demand is P = 130 - Q.
a) If two firms compete in this market with marginal cost c = 10, find the Cournot
equilibrium output and profit per firm.
b) Find the monopoly output and profit if there is only one firm with marginal cost c = 10.
c) Using the information from parts (a) and (b), construct a 2 x 2 payoff matrix where the
strategies available to each of two players are to produce the Cournot equilibrium quantity or
half the monopoly quantity.
d) What is the Nash equilibrium (or equilibria) of the game you constructed in part (c)?
8. Professor Nash announces that he will auction off a $20 bill in a competition between Jack
and Jill, two students chosen randomly at the beginning of class. Each student is to privately
submit a bid on a piece of paper; whoever places the highest bid wins the $20 bill. (In the
event of a tie, each student gets $10.) The catch, however, is that each student must pay

whatever he or she bid, regardless of who wins the auction. Suppose that each student has
only two $1 bills in his or her wallet that day, so the available strategies to each student are to
bid $0, $1, or $2.
a) Write down a 3 x 3 payoff matrix describing this game.
b) Does either student have any dominated strategies?
c) What is the Nash equilibrium in this game?
d) Suppose that Jack and Jill each could borrow money from the other students in the class,
so that each of them had a total of $11 to bid. Would ($11, $11) be a Nash equilibrium?
9. In the mid-1990s, Value Jet wanted to enter the market serving routes that would compete
head to head with Delta Airlines in Atlanta. Value Jet knew that Delta might respond in one of
two ways: Delta could start a price war or it could be accommodating, keeping the price at
a high level. Value Jet had to decide whether it would enter on a small scale or on a large
scale. The annual profits (in zillions of dollars) associated with each strategy are summarized
in the following table (where the first number is the payoff to Value Jet and the second the
payoff to Delta):

a) If Value Jet and Delta choose their strategies simultaneously, what strategies would the two
firms choose at the Nash equilibrium, and what would be the payoff for Value Jet? Explain.
b) As it turned out, Value Jet decided to move first, entering on a small scale. It
communicated this information by issuing a public statement announcing that it had limited
aspirations in this marketplace and had no plans to grow beyond its initial small size. Analyze
the sequential game in which Value Jet chooses small or large in the first stage and then
Delta accommodates or starts a price war in the second stage. Did Value Jet enhance its profit
by moving first and entering on a small scale? If so, how much more did it earn with this
strategy? If not, explain why not?
10. Two firms are competing in an oligopolistic industry. Firm 1, the larger of the two firms,
is contemplating its capacity strategy, which could be either aggressive or passive. The
aggressive strategy involves a large increase in capacity aimed at increasing the firms market
share, while the passive strategy involves no change in the firms capacity. Firm 2, the
smaller competitor, is also pondering its capacity expansion strategy; it will also choose
between an aggressive strategy and a passive strategy. The following table shows the profits
associated with each pair of choices:

a) If both firms decide their strategies simultaneously, what is the Nash equilibrium?
b) If Firm 1 could move first and credibly commit to its capacity expansion strategy, what is
its optimal strategy? What will Firm 2 do?