Question

Firm Aay operates a pool hall in Boom Town. Business has been very profitable. However, there are dark clouds on the horizon. Firm Bee is considering entering the pool hall market in Boom Town. The profits of Aay are 15 if it is a monopoly; if Bee enters and Aay accommodates and shares the market the duopoly profits are 5 for each firm; is Bee enters and Aay launches a price war, both firms earn -1.

a) Draw the game tree for this scenario and determine the subgame perfect equilibrium (SPE).
b) What if launching a price war involves not only charging a low price, but printing flyers to inform the public of the great deals available? If there is a price war, both firms print flyers, and the net result of the price war is -1 for each firm (that is, the -1 takes into account the cost of printing the flyers.) Assume that Aay can have flyers printed up prior to Bee's entry decision and that the printing cost is $8. Draw the game tree for this scenario and determine the subgame perfect equilibrium.
c) What does your answer to (b) imply about the relationship between sunk costs, firstmover advantages, and entry deterrence? plz type down u answer

Answer 1

a). The game tree is attached below. In the game tree, the (SPE) or subgame perfect equilibrium is for Bee firm to enter and Aay firm to accommodate.

b). If launching the price war consists of not only charging low price, but also printing flyers in order to inform the public.

The game tree is attached below.

In the game tree, it can be explained that :

Aay has a priority printing, cost of printing is 8. If he prints and Bee does not enter equilibrium will be (15-8) = 7, 0. Profit if Bee does not enter.

It is given that if Aay enters and Bee enters, there will be price war = -1, -1

or they will accommodate = (5, 8, 5). Here the profit while accommodating is 5 and printing cost is 3. Therefore, (-3, 5)

c). Sunk cost such as that of printing allows Aay to make a credible threat to engage in a prior war and thus deny entry of Bee.

Now when he had first move advantage and make investment in flyers he could make a credible threat and deter entry of Bee. If he did not have the advantage, his treat would not have much of an effect.