Book: Principles of economics (7th edition). No answer in the textbook solution,
ID: 1129414 • Letter: B
Question
Book: Principles of economics (7th edition).
No answer in the textbook solution, for chapter 17, 7PA. The question is below:
7. A conversation between the presidents of American Airlines and Braniff Airways. Let’s analyze the game between the two companies. Suppose that each company can charge either a high price for tickets or a low price. If one company charges $300, it earns low profit if the other company also charges $300 and high profit if the other company charges $600. On the other hand, if the company charges $600, it earns very low profit if the other company charges $300 and medium profit if the other company also charges $600.
a. Draw the decision box for this game.
b. What is the Nash equilibrium in this game? Explain.
c. Is there an outcome that would be better than the Nash equilibrium for both airlines? How could it be achieved? Who would lose if it were achieved?
Explanation / Answer
a)
b) Nash equilibrium - Both airlines would charge price = $300 (this is the dominant strategy for both the firms, they earn a better payoff using this strategy no matter what strategy is opted by the other firm)
c) A better outcome can be reached if both firms collude (enter into an agreement/contract) and charge price = $600. In this case, both firms would earn a medium profit and both of them would be better off. (Consumers/flyers would lose in this case as they would be charged a higher price)
Braniff Airways Price = $300 Price = $600 American Airlines Price = $300 Low profit, Low profit High profit, very low profit Price = $600 very low profit, High profit Medium profit, Medium profit