Question

1. (30 points) There are two firms considering introducing a new product to the market. Each firm can either set a high price or low price for its product. If both set a low price the market will be shared between the two firms. In this case, each firm expects to make a profit of $2m. If one firm sets a high price while the other sets a low price, the former is expected to make $1m and the latter is expected to make $5m. When both set a high price, again, the market will be shared and each firm expects to make a profit of $4m. If both firms know all this information and will choose their prices simultaneously, without knowing what the other chooses, what will be the outcome? What price would each firm pick?

Answer 1

The payoff matrix is shown above. Based on this we can say that if A and B sets low price each will get 2mn profit. If A and B both sets high prices each get 4mn profit. If A sets low price and B sets high price then A gets 5mn and B gets 1mn and if A sets high price and B sets low price then A gets 1mn and B gets 5 mn.

If A sets low prices then he can get either 2mn ot 5mn based on what B decides. If A sets high price he gets 1mn or 4mn based on what B decides. In both cases we can say for A it is best to set low prices and same is the case for B and this is the best strategy for both of them. The Outcome is 2mn each. A choose low price and B also choses low prices