An incumbent monopolist (M) faces a potential entrant (E). E has to decide whether to enter or stay out. Following the action taken by E, I has to decide whether to charge a low price or a high price. The possible outcomes of these decisions are described in the following payoff matrix.
a) Suppose M threatens to set a low price if E should enter. Will E believe the threat? Construct a game tree to help explain your answer. Then derive the subgame perfect equilibrium of this game.
b) If M built the larger plant, would its threat to set a low price if E should enter be credible?
c) Examine whether M will actually build the larger plant – in other words, derive the subgame perfect equilibrium of the three-stage game with choice of plant by M, choice of whether to enter or stay out by E, and choice of price by M.
Thank you.
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