Given the following payoff matrix, (a) indicate the best strategy for each firm.

Question

                    Given the following payoff matrix, (a) indicate the best strategy for each firm. (b) Why is the entry-deterrent threat by firm A to lower the price not                     credible to firm B? (c) What could firm A do to make its threat credible without building excess capacity?                 

                    Firm B                 

                                                                     Enter                         Dont Enter                 

                    Low Price                               (3,21)                              (3,1)                 

                                     Firm A High Price                  (4,5)                               (6,3)

Explanation / Answer

Nash equilibrium is (A) High Price, (B)Enter.

Threat not credible to lower price because it reduces A's payoff (4 to 3).

Building a large plant is not the only way for the incumbent to deter entry by committing

itself to an aggressive response. The incumbent might instead invest in cost-reducing research

and development (R&D), and in that way make producing the low output level a rational

response to entry. Or the ?rm might sign contracts with existing customers that legally bind the

?rm to match any future offer made by an entrant, thus committing the incumbent to ?ght any

attempt by an entrant to take customers away.

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