1) Two firms at the St.

Louis airport have franchises to carry passengers to and from hotels in

downtown St. Louis. These two firms, Metro Limo and Urban Limo, operate nine passenger
vans. These duopolists cannot compete with price, but they can compete through advertising.
Their payoff matrix is below:

a. Does each firm have a dominant strategy? If so, explain and what that strategy is.
b. What is the Nash equilibrium? Explain where the Nash equilibrium occurs in the payoff
matrix.

Answer:
a.
Metro Limo has no dominant strategy. If United Limo advertises, then Metro does best by
advertising; but if United does not advertise, then Metro should not advertise. United has a
dominant strategy, and it should advertise.

b.
The Nash equilibrium is for both firms to advertise. Each does best, 25 and 15, respectively, by
advertising, given what the other firm does.

2) Consider two firms, X and Y, that produce super computers. Each can produce the next
generation super computer for the military (M) or for civilian research (C). However, only one
can successfully produce for both markets simultaneously. Also, if one produces M, the other
might not be able to successfully produce M, because of the limited market. The following
payoff matrix illustrates the problem.

a. Find the Nash equilibrium, and explain why it is a Nash equilibrium.

Answer:
a.
The Nash equilibrium occurs at the bottom right on the C,C position. Firm Y has a dominant
strategy to always target the civilian research market, and Firm X's does not have a dominant
strategy. However, Firm X's best response to Firm Y's dominant strategy is to also target the
civilian market. In this position, each firm does its best given what the other firm does.
3) Mitchell Electronics produces a home video game that has become very popular with children.
Mitchell's managers have reason to believe that Wright Televideo Company is considering
entering the market with a competing product. Mitchell must decide whether to set a high price
to accommodate entry or a low, entry-deterring price. The payoff matrix below shows the profit
outcome for each company under the alternative price and entry strategies. Mitchell's profit is
entered before the comma, and Wright's is after the comma.

a. Does Mitchell have a dominant strategy? Explain.

b. Does Wright have a dominant strategy? Explain.
c. Mitchell's managers have vaguely suggested a willingness to lower price in order to deter
entry. Is this threat credible in light of the payoff matrix above?
d. If the threat is not credible, what changes in the payoff matrix would be necessary to make
the threat credible? What business strategies could Mitchell use to alter the payoff matrix so that
the threat is credible?

Answer:
a.
Mitchell's dominant strategy is the high price. Regardless of Wright's decision to enter, Mitchell
earns a larger profit with a high price.

b.
Wright does not have a dominant strategy. Wright's best choice depends upon the decision made
by Mitchell. When Mitchell sets a high price, Wright should enter, whereas a low Mitchell price
leads to no entry.

c.
Mitchell's threat is not credible. It is obvious that Mitchell's best strategy is to set a high price,
regardless of the decision Wright makes regarding entry.

d.
To make the threat credible, Mitchell's best strategy must be the low price, at least for the case
where Wright enters. A possible business strategy would be for Mitchell to expand capacity,
increasing the profit maximizing quantity.
4) Tony and Larry are managers of baseball teams that currently playing a game. It's late in the
ballgame and Tony's team is currently winning and in the field. Tony's strategies are to bring in
a right handed pitcher (RHP) or to bring in a left handed pitcher (LHP). Larry's strategies are to
bring in a right handed pinch hitter (RPH) or to bring in a left handed pinch hitter (LPH). The
pay-off matrix is in terms of winning (W) or losing (L) the game. Does either player have a
dominant strategy? Does the game have a Nash equilibrium?

Answer: Neither player has a dominant strategy in this game, and there is no Nash equilibrium.

5) Casey's General Store is considering placing a store in Hamilton, Missouri. If they place the
store in Hamilton and no other convenience store enters the Hamilton market, they'll earn profits
of $100,000 per year. If competitors do enter, Casey's profits as well as the competitor's profits
will be reduced to $0 per year. If a competitor enters the Hamilton market and Casey's does not,
the competitor's profits will be $100,000 per year.

Does either player have a dominant strategy? Does the game have any Nash equilibria?

Answer: Both players can do at least as well or better by playing the "ENTER" option regardless
of what their competitor does. This implies both players have a dominant strategy of "ENTER."
The dominant strategy equilibrium is for both players to play "ENTER." This is not the only
Nash equilibrium. This game has three Nash equilibria. The only cell that is not a Nash
equilibrium is the cell corresponding to both players playing the "DO NOT ENTER" strategy.
Given Casey's will not enter the market, the Competitor's best strategy is to enter the market (and
vice versa).
6) Two firms in a local market compete in the manufacture of cyberwidgets. Each firm must
decide if they will engage in product research to innovate their version of the cyberwidget. The
pay-offs of each firm's strategy is a function of the strategy of their competitor as well. The pay-
off matrix is presented below.

Firm #2 chooses to innovate with probability 20/21. If Firm #1 does the same, what is the
expected pay-off? Is this a Mixed Strategy Nash Equilibrium? Suppose, instead, that firm #2
innovates with probability 2/3. Should player #1 always innovate?

Answer: If firm #1 does the same, the expected pay-offs for both firms are zero. This is a Mixed
Strategy Nash Equilibrium. If Firm #2 chooses to innovate with probability 2/3, Firm #1 should
always innovate. This is because the expected profits are as high as possible when firm #1 sets
the probability of choosing to innovate equal to 1.

7) Two firms in a local market compete in the manufacture of cyberwidgets. Each firm must
decide if they will offer a warranty or not. The pay-offs of each firm's strategy is a function of
their competitor as well. The pay-off matrix is presented below.

Does either player have a dominant strategy? Does the game have any Nash equilibria? What is
the maximin strategy of each player in the game? Should the players use a mixed strategy?

Answer: Both players have a dominant strategy to offer a warranty on their cyberwidgets. This
implies the game has a dominant strategy equilibrium of both firms offering a warranty. This is
also the only Nash equilibrium in the game. Each player's maximin strategy is to avoid the -$10
outcome. To avoid this outcome, both player's maximin strategy is to "Offer Warranty." The
players do best by choosing to Offer a Warranty regardless of what their opponent does. Thus,
the optimal mixed strategy is to set the probability of offering a warranty equal to one.
8) Two firms in a local market compete in the manufacture of cyberwidgets. Each firm must
decide if they will offer a warranty or not. The pay-offs of each firm's strategy is a function of
their competitor as well. The pay-off matrix is presented below.

If firm #1 announces it will offer a warranty regardless of what firm #2 does, is this a credible
threat? Why or why not?

Answer: Both firms offering a warranty and both firms offering no warranty are both Nash
Equilibria for this game. Firm #1 prefers the Nash Equilibrium corresponding to both firms
offering a warranty on their cyberwidgets. Firm #1's announcement is a credible threat. Firm #1
actually can always do at least as well or better by offering a warranty. Thus, firm #1's dominant
strategy is to offer a warranty.

9) Two firms in a local market compete in the manufacture of cyberwidgets. Each firm must
decide if it will offer a warranty or not. The pay-offs of each firm's strategy is a function of their
competitor as well. The pay-off matrix is presented below.

xx

If firm #1 announces they will offer a warranty regardless of what firm #2 does, is this a credible
threat? Why or why not?

Answer: Both firms offering a warranty and both firms offering no warranty are both Nash
Equilibria for this game. Firm #1 prefers the Nash Equilibrium corresponding to both firms
offering a warranty on their cyberwidgets. Firm #1's announcement is not a credible threat.
Firm #1 actually can do better by not offering a warranty given firm #2 does not offer a
warranty. Thus, it is in firm #1's best interest to not offer a warranty if firm #2 does not offer a
warranty regardless of firm #1's announcement.