Question

L Question 4 (20 marks) Fairwood and Café de Coral are the two biggest local chains of fast food restaurants with outlets all over Hong Kong. Due to the recent economic recession, suppose that each of the above two firms consider offering 30% off for all its food items to gain competitive edge. The expected annu- al economic profit from each strategy is indicated in the table below: Café de Coral Cut prices $20 million Don't cut prices $5 million Cut prices Fairwood $30 million $40 million $55million $30 million Don't cut prices $20 million $40 million a. What is producer surplus? Suppose both Fairwood and Café de Coral cut prices, other things being constant, how will the producer surplus for the other fast food restaurants in Hong Kong such as McDonald be affected? (8 marks) Answer: b. State the respective dominant strategy for Café de Coral and Fairwood. (4 marks) Answer: C. State the Nash equilibrium for this scenario? Explain. (4 marks) Answer: d. Is there an outcome that would be better than the Nash equilibrium for both Café de Coral and Fairwood? How could it be achieved? (4 marks) Answer: 15

Answer 1

Payoff table.

	Cut	don't cut
Cut	(30*,20•)	(55*,5)
Don't cut	(20,40•)	(40,30)

NE: (cut, cut)

a) producer surplus is the difference between the price charged, & Minimum price at which a firm is willing to sell the good

If these two firms cut the price, then other firms will see a reduction in PS

B) dominant Strategy :

both have dominant strategy : cut the price

C) NE :

Both firms cut at NE

D) yes, there exists an outcome, where both could be better off, & also joint profits are maximized

It is when both don't cut prices