Reaction Paper: Managerial Economics Question Set III a Market

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Managerial Economics Question Set III

A market has only 2 sellers. They are both trying to decide on a pricing strategy. If both firms charge a high price, then each firm will experience a 5% increase in profits. If both firms charge a low price, then each firm will experience a 3% increase in profits. If Firm 1 charges a high price and Firm 2 charges a low price, then Firm 1 will experience a 1% increase in profits and Firm 2 will experience a 6% increase in profits. If Firm 2 charges a high price and Firm 1 charges a low price, then Firm 2 will experience a 2% increase in profits and Firm 1 will experience a 7% increase in profits.

Construct a payoff matrix for this game.

Firm

High Price

Low Price

Firm

High Price

5% / 5%

1% / 6%

Low Price

7% / 2%

3% / 3%

Key:

Firm 1 / Firm

Increase in Profit

Decrease in Profit

Determine whether each firm has a dominant strategy and, if it does, identify the strategy.

This payoff matrix produces a dominant strategy for Firm 1, because when it charges lower prices, the result is either identical 3% gains for both firms when Firm 2 charges low prices, or a 7% to 2% disparity in favor of Firm 1. This is a dominant strategy for Firm 1 because no matter how Firm 2 responds to lower prices, it cannot produce higher gains than its competitor. Firm 2 has the same dominant strategy in this scenario, to charge lower prices, because this route produces identical 3% gains in profit when Firm 1 matches, and a 6% to 1% disparity in favor of Firm 2 when Firm 1 charges higher prices.

Determine the optimal strategy for each firm.

The optimal strategy for Firm 1 is to charge low prices while Firm 2 charges high prices, a scenario which generates a 7% increase in profits for Firm 1, as opposed to a 2% gain for its… [END OF PREVIEW]

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