Question

CHC claims that one factor in the decision to go with 6 labs is that 6 labs will deter entry by others. They provided the following data to support their claim (the numbers are expected profits):

		The Competition
CHC		Do Not Enter	Enter & Compete
	5 or fewer labs	30, 0	5, 10
	6 or more labs	20, 0	2,2

     

Note that CHC has not yet entered the market, so their decision is not yet determined. They are a first-mover, but has not made their first move. After they move, The Competition will move. Given that, what is the outcome of this game? (5 points)

Does either player have a dominant strategy? (5 points)

Is the outcome a Nash Equilibrium? (5 points)

If CHC goes through with the decision to enter with 6 labs as the first mover, what do you expect to happen in the market—what will the competition do, and where will the market eventually settle? (5 points)

Explain how firms can use a commitment to achieve their preferred outcome. Be sure to address the effectiveness of commitments, in particular how sunk cost affects credibility. (15 points)

Answer 1

Ans 1. As CHC is the first mover in the market, the follower will take decision after the move of CHC. If CHC enters with 5 or fewer labs, the opponent gets ‘0’ outcome by not entering into the market. On the other hand, if the opponent enters into the market, the competition starts and CHC gets ‘5’ and opponent gets ‘10’.

If CHC enters with 6 or more labs, they get ‘20’ and the opponents get ‘0’ when opponent does not enter into the market. If both enter with 6 or more labs, the outcome is (2,2), i.e, both will get equal outcome.

Entry is profitable for opponent when competition moves. Therefore, opponent will always choose to enter and compete once CHC moves. In that case, with 5 or few labs, CHC can get profit ‘5’ and with 6 or more labs, they get ‘2’.

Therefore, choosing entry with 5 or fewer labs is more profitable for CHC. Hence, the outcome of this game is (5, 10).

Ans 2. Both players have their dominant strategy. CHC has dominant strategy of entry with 5 or fewer labs as 30> 20 and 5>2

Opponent has dominant strategy to Enter & compete as this strategy would give positive outcome.

Ans 3. Yes, this outcome is a Nash equilibrium as no one wants to deviate from their strategy with given resources and costs.

Ans 4. If CHC takes decision to enter with 6 labs as the first mover, the competition enters and competes with 6 or more labs and market eventually settles into the outcome (2,2). Both get equal share of total profit obtained from the market.