Question

A computer manufacturer, firm A, is considering whether or not to move from the USB-C connector standard to a new, more efficient and cheaper to produce standard called USB4. Most of the accessories for firm A’s computers are produced by firm B. In turn, firm B’s accessories are mainly sold to people using firm A computers. Firm B is currently using the USB-C interface for all the accessories it makes and has been told about firm A considering USB4. Analyse the interaction between the two firms using game theory. Present a payoff matrix to model the situation and analyse it for Nash equilibrium. Which is the best outcome for each firm? Which is the best outcome for society as a whole? What can be done by the firms or government to make society’s best outcome more likely?

Answer 1

		firm B
firm A		new	old
new	8, 8	3, -3
	old	3, -3	5, 5

This payoff matrix shows interaction between firm A and firm B. Both the firms have a trading relationship. Firm B supplies accessories for firm A. So, if firm A changes to new technology (USB4), it only makes sense that firm B aso should change to produce the accessories for new technology. If not he will lose an important deal and lose his client.

If both firm A and B follow new technology, they get the highest payoff,(8,8). If both follow old technology, their payoff is positive, but not as high as new technology would fetch. If one follows old and the other new, then firm A still has a positive payoff, but lower, as he has to find new suppliers. Firm B will lose firm A which leads to a considerable loss.

Firm A knows that firm B has to follow him and do what he does in order to have his business. If he adopts new, firm B will adopt new. If he adopts old, firm B will also adopt old. So, (New, New) and (Old, Old) are the two Nash equilibria.

But, for firm A, between the two options, higher payoff is if he adopts the new technology - USB4. So he will adopt new technology and firm B also follows. The outcome here is (New, New) with payoff (8, 8).

This is good for the society too. New technology is cheaper. So price will be lower. More consumers can afford it now. This increases social welfare as consumer welfare will be more. Producer welfare will also increase as there is more production to meet the increased demand.

The government can decrease taxes on firm A so that it serves as a great incentive to choose USB4, which is more efficient. Moreover, it can instal the new technology in all its departments which will lead to increased demand too.