Question

7. Games in which timing matters Consider an economy in which there is initially one firm, Healthy Breakfast, in the market for breakfast cereal. A new firm, Tasty Cereal, is deciding whether to enter the market, which would then change the market to a duopoly. Healthy Breakfast can choose to sell its cereal to grocery stores at either a high or a low price. As a monopolist, it can earn $6.50 million by selling at a high price or $3.50 million by selling at a low price. If TastyCereal enters the market and Healthy Breakfast sells at a high price, each firm makes $1.50 million; if Tasty Cereal enters the market and HealthyBreakfast sells at a low price, each firm has a loss of $2.50 million.

Answer 1

(A firm would choose higher payoff strategy given the action/s of its competitors)

If Tastycereal decides to enter the market despite the threat, Healthybreakfast would earn - $ 2.5 mn if it chose to set a low price, and it would earn $ 1.5 mn if it chose to set a high price.Therefore, Healthybreakfast's threat is not credible, and Tastycereal would enter the market.

If Healthybreakfast decides to sign a contract at a low price, Tastycereal would earn - $ 2.5 mn if it chose to enter the market, and it would earn $ 0 mn if it chose to stay out. Therefore, if Healthybreakfast signed a contract at low price, Tastycereal would not enter the market, and Healthybreakfast would earn $ 3.5 mn.

On the other hand, if Healthybreakfast decides to sign a contract at a high price, Tastycereal would earn $ 1.5 mn if it chose to enter the market, and it would earn $ 0 mn if it chose to stay out. Therefore, if Healthybreakfast signed a contract at a high price, Tastycereal would enter the market, and Healthybreakfast would earn $ 1.5 mn .

Healthybreakfast will sign a contract at low price (higher payoff)