Assume that initially Boeing has a monopoly in the production of large commercia
ID: 1191621 • Letter: A
Question
Assume that initially Boeing has a monopoly in the production of large commercial aircraft. The monopoly allows Boeing to earn proÖts of $1 billion. Airbus is considering whether to enter the market. If Airbus enters, Boeing has to decide whether to accommodate Airbus peaceably or wage a price war. Under peaceful competition each Örm will make proÖts of $300 million. If there is a price war, each will lose $100 million
(a) Draw a game tree for this game (b) Find the rollback equilibrium and describe the equilibrium strategies.
(b) Find the rollback equilibrium and describe the equilibrium strategies
Explanation / Answer
a) The following is the game tree. Payoffs are written in millions.
b)
If Airbus enters, then Boeing's best response is to accomodate Airbus peacefully. Therefore, the following payoffs shall hold.
That is, if Airbus enters, its payoff will be $300 and that of Boeing will also be $300. If Airbus does not enter, its payoff will be zero and that of Boeing will be $1,000. Airbus will choose to enter as its payoff is higher when it enters in comparison to its payoff when it stays out. Therefore, the equilibrium strategy is "enter" for Airbus and "accomodate peacefully" for Boeing. This strategy is a Nash equilibrium, each player is doing best it can given the other player's strategy, and none has any incentive to change its strategy.