Problem Set 1

Pedro Lopes Pereira #503

Analysis of Industry and Competition
7th Octobr 2010
 Problem Set 1 Pedro Lopes Pereira – Number 503

Question 1

a)

Firm B
H M L
H 19,13 13,1 13,13
Firm A M 12,9 15,7 10,12
L 18,13 8,14 15,17

In this game, the Nash equilibrium (in pure strategies) will be:

NE = {(high, high); (low,low)}

b) Reduced version of the game

Firm B
H M
M 12,9 15,7
Firm A L 18,13 8,14

In this game there is no Nash Equilibrium in pure strategies. In order to find Nash equilibrium in
mixed strategies, we will calculate the probabilities of firm A choosing a medium price or a low
price, and firm B choosing a high price or a medium one. Mixed strategies happen when players
randomize between pure strategies equally profitable to them.

Probabilities:
A: ( , 1 - )
B: ( , 1 - )

The equilibrium will be: [(( ,1- )) ; ( ,1- )}

(M) = 12 + 15 (1 - (H) = 9 + 13 (1 -
(L) = 18 + 8 (1 - (M) = 7 + 14 (1 -

Firm A will randomize when: Firm B will randomize when:

(M) = (L) (M) = (L)

12 + 15 (1 - = 18 + 8 (1 - + 13 (1 - =7 + 14 (1 -
= 7/13 and (1 - = 6/13 = 1/3 and (1 - = 2/13

Nash Equilibrium: {(1/3;2/3) ; (7/13; 6/13)}

Analysis of Industry and Competition | Professor: Luis Vasconcelos 2

 Problem Set 1 Pedro Lopes Pereira – Number 503

c)

Firm A

High Medium Low

Firm B Firm B Firm B

ss

H M L H M L H M L

(19,13) (13,10) (13,13) (12,9) (15,7) (10,12) (18,13) (8,14) (15,17)

The 3 dashed circles respresent the sub-games of the main game:

- Firm A will choose from 3 different strategies ; High, Medium or Low

- Firm B will choose from 27 strategies; (H,H,H), (H,H,M), (H,H,L), (H,M,H), (H,M,M), (H,M,L),
(H,L,H), (H,L,M), (H,L,L), (M,H,H), (M,H,M), (M,H,L), (M,M,H), (M,M,M), (M,M,L), (M,L,H),
(M,L,M), (M,L,L), (L,H,H), (L,H,M), (L,H,L), (L,M,H), (L,M,M), (L,M,L), (L,L,H), (L,L,M), (L,L,L)

The SPNE of this game is the blue circle on the picture (H,(H,L,L))

Analysis of Industry and Competition | Professor: Luis Vasconcelos 3

 Problem Set 1 Pedro Lopes Pereira – Number 503

Question 2
a) Assuming that consumers with the exact same price charged opt for the nearest point of sales within
a one mile straight line, location chosen by each vendor becomes determinant on his own sales. On the
vendor perspective, the market could be easily dived in two equal parts. Yet each one would always
think to obtain the maximum profit of the market by getting the higher slice as possible. Given that they
chose locations simultaneously the game becomes more linear and clear.

If both vendors opt to pick the midpoint of the boardwalk, all customers within that range would
converge to that same points and thus, profits would be equally shared. However, if one of them, for
instance Vendor B opt by deviating for that same point to the right side, vendor A would still get half
market exclusively for him, while vendor B would have additionally to share the market located on the
gap between them, created by this deviation.

In numerical numbers, if for example a firm opts to deviate 0,1 mile from the center it would lose 5% of
market share because on those 0,1 miles are presented 10% of the market that would began being
shared among them. The market share would be 55% vs 45%. That is why the middle point is a Nash
Equilibria.

A Nash Equilibrium is a profile of strategies in which each player’s strategy is its optimal strategy given
the strategies of the other players. Both vendors would be better off picking the midpoint of the street.
No vendor would be better off deviating from this strategy.

b) Now considering three vendors instead of two, and keeping the same rules such as “If more than one
vendor is at the same location, they split the business evenly”, if all three vendors would pick the
midpoint, they would share in 3 equal parts the profits from sales, being 33% of market share for each
other. However, if any of those vendors decided to “deviate” from this strategy, by picking a place closer
to the left/right end of the street, he would take more profit that by sharing the customers with two
other vendors. He would have approximately half of the market for himself while the other two would
have to split the other half between them.

If vendor C moves slightly to the left side, all customers from the left end of the street would stop at his
place, because it would be the closest one. By “deviating” from the “midpoint strategy”, a vendor would
have a better payoff. As such, there is no NE when considering 3 vendors in these circumstances as any
vendor would prefer deviating from the “midpoint strategy”.

Analysis of Industry and Competition | Professor: Luis Vasconcelos 4

 Problem Set 1 Pedro Lopes Pereira – Number 503

Question 3

a) Representation of the game in the strategic form

Firm I
Fight if entry Accommodate
occurs if entry occurs
Stay Out 0,3
Firm E Enter & fight -2,0 2,3
Enter & Acc -1,0 4,2

Representing the game in the extensive form

b)
Firm I
Fight if entry Accommodate
occurs if entry occurs
Stay Out 0,3

Firm E Enter & fight -2,0 2,3

Enter & Acc -1,0 4,2*

There are two Nash Equilibria in this game:

1) Entrant stays out; Incumbent fights if entry occurs
2) Entrant enters and accommodate; incumbent accommodates if entry occurs
Only the second hypothesis is a Sub-game Perfect Nash Equilibria (SPNE)

c) Considering a change in the payoffs on the same actions we would have the following default:
Firm I
Fight if entry Accommodate
occurs if entry occurs
Stay Out 0,3 0,3
Firm E Enter & fight -2,0 2,3
Enter & Acc -1,2 4,2*

We would still have the same NE: {(E,A);A)} and {(SO);(F)}. The {(E,A);A)} hypothesis would still be the
Sub-game Perfect Nash Equilibria (SPNE) of this game.

Analysis of Industry and Competition | Professor: Luis Vasconcelos 5

 Problem Set 1 Pedro Lopes Pereira – Number 503

d)
i) Representing the game in the strategic form:

Firm I
Fight if entry Accommodate
occurs if entry occurs
Stay Out 0,3
Firm E Enter & fight -2,0 2,3
Enter & Acc -1,0 4,2

Extensive form:

ii) There are two Nash equilibriums in this game:

1. (Entrant stays out; Incumbent fights if entry)

2. Entrant enters and accommodate; Incumbent accommodates if entry occurs

iii) The SPNE is {Entrant enters and accommodate; Incumbent accommodates}

Analysis of Industry and Competition | Professor: Luis Vasconcelos 6

 Problem Set 1 Pedro Lopes Pereira – Number 503

Question 4

a) In the case that the government’s announcement is not biding and has no effect payoffs, we have the
following extensive form:

(2;0) (3;1) (0; -1/2) (1; 1/2)

b) In the case that the government’s announcement constrains to implement the transfer rules, the
government can announce 4 different transfers’ rules:

Designed by the following extensive form:

Analysis of Industry and Competition | Professor: Luis Vasconcelos 7

 Problem Set 1 Pedro Lopes Pereira – Number 503

c)

Representing the game of a) in the extensive form

Player 2
Game (a)
0 1

0 (2;0) (3;1)
Government
1 (0; -1/2) (0; 1/2)

Player 2
Game (b)
0 1
= (0,0) (2,0) (0,-1/2)
= (0,1) (2,0) (1,1/2)
Government = (1,0) (3,1)* (0,-1/2)
= (1,1) (3,1)* (1,1/2)

d) In the game a) there is a Nash equilibrium (in pure strategies): NE = {(a=0, (t=1)}. This Nash
Equilibrium is also subgame perfect Nash Equilibrium.

In the b) game we can find 3 Nash equilibriums (in pure strategies):

NE = {((1,0), 0); ((1,1), 0); ((0,1),1)}

Between the 3 Nash equilibriums found, there are only 2 that are subgames perfect Nash equilibriums:

SPNE = {(1,0), 0} & {(1,1), 0}

Analysis of Industry and Competition | Professor: Luis Vasconcelos 8