Question

1. Boeing and Airbus are the world’s only major producers of large, wide-bodied aircrafts. But with the cost of fuel increasing and changing demand in the airline industry, the need for smaller regional jets has increased Suppose that both firms must decide whether they will produce a smaller plane We will assume that Boeing has slight cost advantage over Airbus in both large and small planes, as shown in the payoff matrix below (in millions of U.S. dollars). Assume that each producer chooses to produce only large or small planes.

		Airbus
		Large planes	Small planes
Boeing	Large planes	10, -5	115, 125
	Small planes	150, 50	15, 0

1. What are the outcomes and explain why you think they are.

2. Now suppose the European government wants Airbus to be the sole producer in the lucrative small-aircraft market. What is the minimum amount of subsidy that Airbus must receive when it produces small aircraft to ensure that outcome as the unique Nash equilibrium.
3. It is worthwhile for the European government to undertake this subsidy?

Answer 1

a)

Being: Selects the Large planes, the Airbus will go with SMALL PLANE strategy,

If Being selects the SMALL PLANE, then AIRBUS chooses the LARGE PLANE.

If AIRBUS selects any strategy, the BOEING will respond in similar Fashion.

Thus Nash Equilibrium: ( Large plane: Small Plane) And ( Small Plane: Large Plane)

b)

Airbus will select the strategy of small plane only if it is dominant strategy. Subsidy of at least $ 50 would make it dominant strategy.

Thus, Government needs to provide the $ 50 subsidy.

Now unique nash equilibrium will be : ( Large plane: Small plane)

It will not be worthwhile to pursue such action as firm was already at same nash equilibrium. Its benefit is that it makes the small plane strategy as dominant strategy. it ensure the minimum profit equal to 75 ( 150-50)