Question

Q6. [25 marks] Two firms are interested in undertaking Research and Development (R&D) to create a new drug. If one firm undertakes R&D and the other doesn't, the firm undertaking the R&D is likely successful and gets a net return of $40m in the following year; but corporate espionage means the other firm gains some information and is able to make some improvements which lead to a $10m increase in the following year. If both firms undertake R&D then rivalry and the inability to gain a patent means that both will benefit by $8m in the following year. However, if neither undertake the R&D then it's likely that profits will increase by only $5m in the following year. a. [5 marks] Draw up the payoff matrix for this situation. b. [10 marks] In a one-shot simultaneous game - what is the expected outcome? Explain. c. [10 marks] Are there any first-mover advantages if this 'game' was not played simultaneously? Explain.

Answer 1

Action S R&D o { NO RED] as Payoll maliy RRD Firm Rinal RED NORED (8, B) t (10, 40h (5,5) * (40, 100 1 Payoll's an in million collay NOREO Але b) To find the outcome will find the best responses, Firm, : BRr (R&D] = No R&D BRE[NO R&D] = RED Rinal! BRR [ R&D] - No R&D BRRINORED] - R&D. So, nash equilibriums are [RED, NO R&D] (No R&D, R&D) c) under sequential (Firen RED NORED Rinal Pium CPD NO KED RED RED 18,6) (40,10) (10,40) (5,5), Using backward induction at stage ③ runal will choon NO RED ich Pian choose R&D at first stage. Similarly rital will choose. RED il

chooses NO R&D at fitum ac in first first stage. the fiem first shape Looking so sender sequential game the firm gets a payoff of 140 million. Therefore, there is a first monar na aduantage.. sequential at this choose RED, will under game: