Question

Han Solo and Buba Fettare the only two smugglers in the Western Reaches. They have been colluding, sharing the market and earning monopoly profits of $100,000 each for several years. Bubba Fett is considering reducing his price. He estimates that if Han Solo keeps his price at current levels, Bubba Fettwould earn $150,00,although Han Solo’s earnings would fall to $25,000. There is also the possibility that Han Solo would compete against Bubba Fett.The resulting price war would reduce the earnings of each to $40,000.a. Set up a payoff matrix above with Han Solo on top.b. Is there a dominate strategy for either plyer? If so, what is it for each person?c. What is the Nash equilibrium outcome? Explain the intuition behind this.

Answer 1

A dominant strategy is when the strategy is best for best for one player. It doesn't have to be best for the other,

Nash equilibrium is when each player has no incentive to change their option.

Payoff Matrix:

Han Solo

Same Price Reduce Price

Buba Fettare Same Price 100,000/100,000 25,000/150,000

Reduce Price 150,000/25,000 40,000/40,000

Nash Equilibrium would be that both Han Solo and Buba Fettare would keep the same price.

Dominant strategy for each player is to reduce price but if both reduce then there is no dominant strategy.