Suppose that McDonalds and Yum Brands are the sole producers of a quadruple-deck
ID: 1109263 • Letter: S
Question
Suppose that McDonalds and Yum Brands are the sole producers of a quadruple-decker chicken and hamburger sandwich. The two firms currently charge the same price for their products. If neither firm reduces the price of its quadruple-decker chicken and hamburger sandwich, each firm earns $40 million in profit. If both firms reduce their prices, then each firm will earn $10 million in profit. If one firm reduces its price and the other does not, then the firm that reduces price will earn a profit of $70 million while the other firm will earn a profit of $2 million.
Assuming that collusion is not a possibility, the Nash equilibrium occurs when
.B. both firms will maintain their current price.
C. Yum Brands will reduce its price and McDonalds will maintain its current price.
D. both firms will reduce their price.
Explanation / Answer
If McDonalds keeps same price then Yum Brands can earn $40 million if it keeps the same price and $70 million if it reduces the price.
Since, profit is higher in case of price reduction, Yum Brands will reduce price if McDonalds keeps the price same.
If McDonalds reduces price then Yum Brands can earn $2 million if it keeps the same price and $10 million if it reduces the price.
Since, profit is higher in case of price reduction, Yum Brands will reduce price if McDonalds reduces price.
Thus, Yum Brand will reduce price irrespective of the action taken by McDonalds.
So, reduce price is dominant strategy for Yum Brands.
If Yum Brands keeps same price then McDonalds can earn $40 million if it keeps the same price and $70 million if it reduces the price.
Since, profit is higher in case of price reduction, McDonalds will reduce price if Yum Brands keeps the price same.
If Yum Brands reduces price then McDonalds can earn $2 million if it keeps the same price and $10 million if it reduces the price.
Since, profit is higher in case of price reduction, McDonalds will reduce price if Yum Brands reduces price.
Thus, McDonalds will reduce price irrespective of the action taken by Yum Brands.
So, reduce price is dominant strategy for McDonalds.
The combination of dominant strategies is the Nash Equilibrium.
Thus, Nash equilibrium of this game occurs when both firm reduces price.
Hence, the correct answer is the option (D).