Microeconomics: Construct a payoff matrix to describe the following situation. T
ID: 1106470 • Letter: M
Question
Microeconomics:
Construct a payoff matrix to describe the following situation. Two competing car dealers are deciding whether or not to be open 7 days a week. Currently they are both closed on Sunday (assume it is legal for them to be open on Sunday). The payoff matrix should contain your guesses as to their profits. Each firm’s profits will depend on its action and the action of its rival. (It is the relative sizes of payoffs that are important, not their absolute magnitudes.)
Explain your reasoning in determining the values in the payoff matrix.
Explanation / Answer
Solution:
Payoff Marix
To understand the above payoff matrix, please refer following points:
1) If both car dealer are closed on sunday then profit for both will be 110 each.
2) If both car dealer work on sunday then profit will be 100 each.
3) If dealer A work on sunday then he can earn 120 i.e. more than 110
The dominant strategy for a dealer is one that produces the best payoff regardless of the strategies employed by others. The dominant strategy here is for each dealer is to remain open on sunday, since working on sunday would maximize the gain for an individual dealer.
If both dealers think only to maximize his profit share then they will opt for working on sunday as well which will led to gain of 10 (120-110) more of keeping closed of sunday i.e. 110.
Now the concept of NASH equilibirum can be used to further evaluate the problem:
Nash equilibrium requires that every player maximizes his/her utility given some beliefs about what other players will do and that the beliefs are correct. Hence, unlike dominant strategy equilibrium the concept of Nash equilibrium requires rational expectations-every agent knows exactly what the other players are going to do in a Nash equilibrium.