Suppose that the Little Varmint Undergarment Corporation is a dominant firm in t
ID: 1118924 • Letter: S
Question
Suppose that the Little Varmint Undergarment Corporation is a dominant firm in the market for children's underwear. The firm is currently earning large economic profits due to its dominant position. However, these high economic profits have attracted the attention of a new firm. This firm is considering entering the industry. f it does so, the Little Varmint Undergarment Corporation will have to decide whether or not to fight a price war. The profits from fighting a price war (setting a low post-entry price) or accommodating entry (setting a high post-entry price) are given below with the Little Varmint undergarment Corporation's profits listed first in each cell. What is the Nash equilibrium outcome? Explain. Potential Entrant Enter Stay Out 90,0 High Post 50, 10 Entry Price Little Varmint Undergarment Corporation 70, 0 Low Post- Entry Price 30,-10 Now, suppose that Little Varmint is considering a strategic move to limit entry. t is considering installing capacity beyond what it needs if the potential entrant remains out of the industry. This extra capacity will be costly unless entry occurs and a price war breaks out. Thus, it lowers Little Varmint's profits by SX unless this occurs. On the other hand, this extra capacity makes it easier to fight a price war if entry does occur. Let's suppose that the extra capacity increases Little Varmint's profits and lowers the potential entrant's profits by $Y if entry occurs and a price war breaks out. This means that if the capacity is installed, the profit rates will become: Potential Entrant Enter Stay Out 90-x, 0 High Post 50-X, 10 Entry Price Little Varmint Undergarment ow Post-30Y,-(10+Y) Entry Price 70,0 Suppose that Y = 5 and X-20. Should Little Varmint install the extra capacity? why or why not? Suppose that Y = 5 and X-10. Should Little Varmint install the capacity? why or why not?Explanation / Answer
Nash equilibrium is potential entrant to enter and vermint garment to set high post price. Little vermint gets higher payoff with setting high post price and potential entrant prefers to enter when virmint garment costs high post price and prefers to stay out when virmint chooses low post price. Highest payoff is when vermint chooses high post price and event to enter.
When Y= 5 and X=20 , payoff Matrix is the following
30,10. 70,0
35,-15. 70,0
Yes Varmint should install extra capacity because with excess capacity it is able to keep the new out of the business and also it is able to choose low price. This is because now the Nash equilibrium is Varmint to choose low post price and potential entrant to stay out.
When Y=5 X=10, payoff Matrix becomes
40,10. 80,0
35,-15. 70,0
Vermint should not install extra capacity as now the Nash equilibrium is Varmint to choose to high post price and potential entrant to enter as this combination pesticides highest payoff given each other's decisions.
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