Question

. Two interdependent bus companies—City Wheels and Easy Ride—provide transportation services in the same city. Following a change in costs that affects both companies, each company must decide whether to lower its fare or maintain its current fare. In the payoff matrix below, the first entry in each cell indicates the daily profit to Easy Ride and the second entry indicates the daily profit to City Wheels. Both companies know all of the information in the matrix.

City Wheels Maintain Fare Lower Fare $150, $180 $130, $120 Maintain Fare Easy Ride $120, $130 $140, $110 Lower Fare

(a) If Easy Ride chooses to maintain its current fare, which strategy is better for City Wheels? Explain.

(b) Is there a dominant strategy for Easy Ride? Explain.

(c) Assume that the companies must make their decisions simultaneously and do not cooperate. What will be the daily profit for each firm?

(d) If these two firms could cooperate, which strategy would each firm choose?

(e) Suppose that the local government decides to provide a subsidy of $40 per day to the bus companies.

Answer 1

(a) If Easy Ride chooses to maintain its current fare, City Wheels will find that its payoff is 180 when it also maintains and 120 when it reduces its fare. Hence it decides to maintain the fare as well to get a higher payoff.

(b) There is no dominant strategy for Easy Ride. When City Wheels maintains its fare, its payoff are higher in maintaining fare as well but when City Wheels reduces its fare, Easy Ride will follow and reduce its fare to get a higher payoff of 140

(c) Simultaneous decision making has City Wheels using its dominant strategy to maintain the fares and Easy Ride to follow and maintains the fare. This implies (maintain fare, maintain fare) is the optimal solution (Nash equilibrium)

(d) If these two firms could cooperate, (maintain fare, maintain fare) will still be the Nash equilibrium because their profits are higher