Consider an economy in which there is initially one firm, HealthyBran, in the ma
ID: 1117762 • Letter: C
Question
Consider an economy in which there is initially one firm, HealthyBran, in the market for breakfast cereal. A new firm, TastyCereal, is deciding whether to enter the market, which would then change the market to a duopoly. HealthyBran can choose to sell its cereal to grocery stores at either a high or a low price. As a monopolist, it can earn $6.5 million by selling at a high price or $3.5 million by selling at a low price. If TastyCereal enters the market and HealthyBran sells at a high price, each firm makes $1.5 million; if TastyCereal enters the market and HealthyBran sells at a low price, each firm has a loss of $2.5 million Suppose that HealthyBran can't set long-term contracts with the grocery stores that sell its cereal. The following diagram shows this game: first TastyCereal decides whether to enter or not, and then HealthyBran decides whether to sell at a high or low price. $2.5 Million for HealthyBran $2.5 Million for TastyCereal Low Erter $1.5 Million for HealthyBran 1.5 Million for TastyCereal IHigh Price 3.5 Million for HealthyBran $0 Million for TastyCereal I Low Price Dont Er High 6.5 Million for Healthy BranExplanation / Answer
PART 1
As per the given figure,
If TastyCereal decides to enter the market despite the threat, HealthyBran would earn -$2.5 million if it choose to set a low price, and it would earn $1.5 million if it choose to set a high price.
It can be seen that with entry of TastyCereal, HealthyBran can earn more by setting high price.
Therefore, HealthyBran's threat is not credible, and TastyCereal Would enter the market.
PART 2
If HealthyBran decides to sign a contract at a low price, TastyCereal would earn -$2.5 million if it choose to enter the market, and it would earn $0 million if it choose to stay out. Therefore, if HealthyBran signed a contract at low price, TastyCereal would not enter the market and HealthyBran would earn $3.5 million.
On the other hand, if HealthyBran decides to sign a contract at high price, TastyCereal would earn $1.5 million if it chose to enter the market, and it would earn $0 million if it chose to stay out. Therefore, if HealthBran signed a contract at a high price, TastyCereal would enter the market, and HealthBran would earn $1.5 million.
Anticipating TastyCereal's response to its pricing contract, HealthyBran will sign a contract at low price.