Question

Suppose a company spent $13 million developing a new 100 -hour innovative laptop battery, but just discovered these batteries have a defect which could make them randomly catch on fire after several years of use. The only way to fix this is by investing another $4 million as a one-time cost to develop additional features including safety software. The Regulator in this industry is either corrupt or lazy, so it is possible to enter the market regardless of whether this fire safety issue is fixed. The estimated market demand for the dangerous product in its current state is a quantity of 2 million units and the market price is set at $3 due to existing non-negotiable legal agreements with distributors. The estimated market demand for the improved product with safety software is 1.5 million units and the market price would be set at $4 due to the perceived benefits of the extra features. The variable cost of producing dangerous batteries is $1 per unit and the variable cost of producing safety software batteries is $2 per unit. a) What will a logical, risk-neutral, profit-maximizing CEO of this company decide to do? b) Suppose there is a rational, selfish, morally indifferent Senator in charge of regulatory oversight. The Senator discovers that the industry Regulator is either corrupt or lazy and therefore failing to ensure product safety. If the Senator investigates, then the company will not be able to sell dangerous batteries, Using only the following game (with the units for given payoff values in millions of dollars) explain what will happen: C) Consider the Nash Equilibrium outcome from the game above to explain what the company will do now. Suppose the company discovers it can influence policy by donating to the Senator's campaign: d) What is the most this company would be willing to donate in exchange for the Senator deciding to reappoint the Regulator? (Remember that the units for the matrix payoffs above is millions of dollars) e) Assuming the company knows all of the values in the matrix game above, how much should it offer to donate to the Senator? Suppose the firm can now cut costs by $500,000 by dumping toxic waste in the river (regardless of whether it produces dangerous or safe batteries) if the industry Regulator is corrupt. Based on the matrix payoffs, how much should the firm offer to bribe the Regulator to be corrupt instead of lazy?

Answer 1

A risk-neutral profit-maximizing CEO would likely opt for the safer battery development due to higher expected profits. In a scenario involving a corrupt or lazy regulator, and a Senator, the Nash Equilibrium suggests the company might donate to affect the Senator's actions. The firm would offer a bribe to the regulator that is less than the cost savings from illegal dumping, although such an action is ethically questionable.

Step-by-step explanation:

Given the scenario where Suppose a company spent $13 million developing a new 100-hour innovative laptop battery, and then faced an additional $4 million in development costs for safety features to address a potential fire risk, a risk-neutral, profit-maximizing CEO is faced with a decision. Considering the cost and market demand, the CEO will compare the expected profit from selling 2 million units at $3 with a $1 production cost (without safety features), and 1.5 million units at $4 with a $2 production cost (with safety features). The calculation shows a higher expected profit for the safer battery option, leading the CEO to choose that route.

In the situation with a corrupt or lazy regulator and a Senator with regulatory oversight, the game-theoretical analysis comes into play. The Senator can choose to investigate, leading to the company being forced to sell only the safe batteries. A Nash Equilibrium occurs where the Senator does not investigate, allowing the company to make a choice without restriction. Given this, the firm may consider donating to the Senator's campaign to ensure a favorable decision - the maximum donation would be just under the additional profit they would earn by selling the unsafe batteries without investigation.

Lastly, if the firm can cut costs by $500,000 by dumping toxic waste illegally, it must consider the consequences of such actions, including legal penalties and damage to its reputation. However, from a purely profit-maximizing and amoral standpoint, the firm would offer a bribe to the regulator that is less than the cost savings to maximize profit. The decision illustrates a conflict between ethical considerations and profit maximization in business decisions.