Question

Little Kona is a small coffee company that is considering entering a market dominated by Big Brew. Each company's profit depends on whether Little Kona enters and whether Big Brew sets a high price or a low price:

		Big Brew
		High Price	Low Price
Little Kona	Enter	$3 million, $5 million	-$1 million, $2 million
	Don't Enter	$0, $10 million	$0, $4 million

True or False: Only Little Kona has a dominant strategy in this game.

True

False

Which of the following outcomes represent a Nash equilibrium in this case? Check all that apply.

Big Brew maintains a low price and Little Kona does not enter.

Big Brew maintains a high price and Little Kona does not enter.

Big Brew maintains a low price and Little Kona enters.

Big Brew maintains a high price and Little Kona enters.

Big Brew threatens Little Kona by saying, “If you enter, we're going to set a low price, so you had better stay out.”

True or False: Little Kona should not believe the threat.

True

False

If the two firms could collude and agree on how to split the total profits, what outcome would they pick?

Big Brew maintains a low price and Little Kona does not enter.

Big Brew maintains a high price and Little Kona enters.

Big Brew maintains a low price and Little Kona enters.

Big Brew maintains a high price and Little Kona does not enter.

Answer 1

1. The statement is false. (Only Big Brew has a dominant strategy - no matter what Little Kona opts for, Big Brew earns a higher payoff using this strategy i.e. Set a high price)

2. Correct option:

- Big Brew maintains a high price and Little Kona enters. (Big Brew adopts the dominant strategy and Little Kona opts for the best strategy given the strategy adopted by Big Brew)

3. The statement is true (it is not a credible threat, dominant strategy is to price high)

4. Correct option:

- Big Brew maintains a high price and Little Kona does not enter. (maximum total profits are earned when these strategies are chosen)