Question

Imagine two fictional airline manufacturing companies, Nechako Jet and Air Fraser, are in a fierce competition to sell their corporate jets. In 2019, Nechako’s “Brown Bear” has 1500 orders. Fraser’s “Wolverine” has 1550 orders this year. Background Data: Aircraft Price Aircraft Price Nechako Brown Bear $19,000,000 Fraser Wolverine $18,500,000 Assumptions:  Assume that the performance and operating costs of the two aircraft are the same.  At list price, both Nechako and Fraser can get another 200 orders each, and make 4 Mn in economic profit.  At discounted prices, each manufacturer can get an additional 225 orders each and make 2 Mn in economic profit.  If one keeps the list price and the other discounts, the discounter can get 450 new orders and make 6 Mn, and the other will get no new orders a) What type of market is described above? (2 pts) b) Given the assumptions above, will the companies discount their prices, or stick to list price? Answer this question by illustrating the payoff matrix: (8 pts) c) Identify the Nash Equilibrium and name the game strategy they will pursue. (4 pts)

Answer 1

(a) The market described in the question is oligopoly market structure. The oligopoly market structure is defined as the market in which there are couple of big firm operating and the pricing decision of one firms affects the price and profits of other firm. In this question Nechako jet and air frasar are in fierce competition to sell their corporate jets.

(b) To construct the payoff matrix of this game we need to first specify the players and their possible strategies.

This 2×2 that is two player two startegies game. The two player here are Nechako jet and air fraser and they each have two startegies. They can either offer list price or discounted price.

Now let's fill the payoffs in the matrix.

When Nechako jets offers list price and air fraser also offers list price. When both of them offer list price they both earn 4mn in economic profits. So the first entry is (4mn,4mn).

When Nechako jet offers list price but air fraser offers discounted price. In this case as given in the question when one offers the discounted price and other offers list price. The one who offers discounted price gets 6mn in economic profits and the one who offers list price gets nothing. So that's why we have second entry in first row as (0,6mn).

When Nechako jet offers discount price and air fraser offer list price. Now since the Nechako jet is offering discounted price and air frasar is offering list price then Nechako jet will get 6mn in economic profits and air fraser will get nothing. That's why the first entry in the second row we have (6mn,0).

When both Nechako jet and air fraser offers discounted price, as given in the question when both Nechako jet and air fraser offers discounted price they both gets 2mn in economic profits. Hence we have second entry in second row as (2mn,2mn).

To answer whether companies are going discount their prices or stick to the list prices we need to find out the nash equilibrium of this game.

(C) Now let's calculate the nash equilibrium of this game using the underlying the best strategy method. In this method we will find out the best strategy for each player given that other player is playing his strategy.

Let's first find out the best strategy for Nechako jet.

When air fraser stick with list price the Nechako jet can wither choose to discount their price and get 6mn in economic profits or stick with list price and get 4mn in economic profits. As you can see 6mn in economic profits is better than 4mn in economic profits so the best strategy for Nechako jet is to discount their prices. Hence we underline 6mn.

When air fraser is discounting his price, again Nechako jet can choose to either stick with the list price or discount their price. If Nechako jet choose to stick with list price the it get nothing but if it chooses to discount prices then it will get 2mn in economic profits. So as you can see 2mn is better than nothing, the best strategy for Nechako jet is to discount their prices. Hence we underline 2mn.

Now let's find out the best strategy for air fraser.

When Nechako jet is choosing to stick with list price. Air fraser can either choose to stick with list price and get 4mn in economic profits or it can choose to discount its price and get 6mn in economic profits. As you can see that 6mn in economic profits is higher than 4mn in economic profits. The best strategy for air fraser to choose discount their prices and hence we underline 6mn.

And when Nechako jet is choosing to discount its prices again air fraser can either choose to stick with list price and get nothing or it can choose to discount its prices and get 2mn in economic profits. As you can see that 2mn in economic profits is better than getting nothing. So the best strategy for air fraser is to discount their prices and hence we underline 2mn.

We have found the best startegies for the companies and notice one thing that irrespective of what other company is doing each company is choosing to discount its prices. And this is the nash equilibrium of this game. That both companies will discount their prices and will get 2mn each in economic profits.

Nash equilibrium is that both companies Nechako jet and air fraser will choose to discount their prices and will get 2mn each in economic profits.