Consider the following sequential game between firm 1 and firm 2. First, firm 1
ID: 1158483 • Letter: C
Question
Consider the following sequential game between firm 1 and firm 2. First, firm 1 decides to either adopt an aggressive marketing strategy or not. Second, Firm 2 observes firm 1's decision and then also decides between its own aggressive strategy, a passive strategy or whether to leave the market altogether. The profits (in millions of dollars) of the firms are as follows: If both adopt an aggressive strategy, then firm 1's payoff is $14 and firm 2's is –$1. If firm 1 adopts an aggressive strategy and firm 2 does not, then the payoff for firm 1 is $19 and for firm 2 is –$5. If firm 1 does nothing and firm 2 adopts an aggressive strategy, firm 1's payoff is $10 and firm 2's is $9. If both do nothing, then firm 1 makes $20 in profits and firm 2 makes $5. Finally, if firm 2 leaves the market altogether, it makes $0 and firm 1 makes $20 with an aggressive strategy and $24 without one.
Now assume that Firm 2 has the chance of preempting Firm 1’s move. That is, firm 2 has the opportunity to publicly commit to its strategy (of being aggressive, passive or leaving) before firm 1 decides what to do. Then firm 2 should:
A)Pre-empt firm one by committing to an aggressive strategy
B)Pre-empt firm one by committing to a passive strategy
C)Not pre-empt firm one and wait to see what it does.
D)Not care whether to pre-empt firm 1 or not since the outcome will be to leave the market altogether regardless.
A)Pre-empt firm one by committing to an aggressive strategy
B)Pre-empt firm one by committing to a passive strategy
C)Not pre-empt firm one and wait to see what it does.
D)Not care whether to pre-empt firm 1 or not since the outcome will be to leave the market altogether regardless.
Explanation / Answer
Lets first summaries the payoffs in the extensive form
So if Firm 2 get the opportunity to publicly commit to its strategy (of being aggressive, passive or leaving) before firm 1 decides what to do. Then firm 2 should:
- If firm 2 chooses to be aggressive it could either earn a pay off of $9 or bear a loss of $1 depends on the decision of firm 1. So we look up the decision of firm 1, if Firm 2 chooses to be aggressive the best startegy for firm 1 is to choose aggressive because firm 1 get a payoff of $14 with choosing aggressive strategy and get $10 with choosing non aggressive strategy so firm 1 will choose aggressive if firm 2 chooses aggressive startegy which means the outcome will be ($14, -$1)
so it is not best for firm 2 to pre-empt firm 1 by committing to an aggressive startegy because it will bear a loss of $1 if it do so.
It meas option a) is incorrect.
- If firm 2 chooses passive strategy, it will earn a pay off of $5 or could loss $5 based on the decision of firm 1. If firm 2 chooses passive strategy, the best strategy for firm 1 is to choose non aggressive because it will get higher payoff with choosing non aggressive strategy than aggressive strategy ($20 > $19) when firm 2 chooses passive strategy.
So firm 2 will earn $5 if it chooses a passive strategy.
it means option B) is correct, Firm 2 should pre- empt firm 1 by committing to a passive strategy.
Option C) is incorrect because Firm 2 should pre- empt firm 1 by committing to a passive strategy and able to get a payoff of $5.
option D) is also incorrect because if firm 2 will leave the market it cannot earn anything but if it pre- empt firm 1 by committing to a passive strategy it could earn $5 payoff.
So correct option is B).Firm 2 should pre- empt firm 1 by committing to a passive strategy.
Firm 2 Firm 1 Strategies Aggressive Passive Leave market Aggressive 14, -1 19, -5 20, 0 Not Aggressive 10, 9 20, 5 24, 0