Suppose only two firs exist in producing coffee, Dutch Bros and Starbucks. They

Question

Suppose only two firs exist in producing coffee, Dutch Bros and Starbucks. They are deciding whether to enter the market in Klamath Falls or not. If only one enters the market it will earn monopoly profits and pay off the other firm to keep it from entering later. If both firms enter, they engage in a price war that reduces each firms' profits to the long-run competitive outcome of zero profits. If neither firm enters, no market exists, and profits are zero for each firm. The payoff matrix below represents this payoffs are profits in millions of dollars: Starbucks Enter Don't Enter Enter0,0 Dutch Bros Don't Enter 1.5 0 (a) What is the Nash equilibrium/equilibria of this game? (b) Based on your answer to a), what would you expect to happen in this industry in Klamath Falls (i.e Ilow many store do you expect to open, and who would own them) Now suppose that if both firms enter that they compete, but their price war is much less fierce so that both firms earn positive profits. This is represented in the payoff matrix below: Starbucks EnterDon't Enter Enter Dutch Bros Don't Enter 0.0 (c) What is the Nash equilibrium/equilibria of this game? (d) Based on your answer to e), what would you expect to happen under this scenario in this industry in Klamath Falls (i.e How many store do you expect to open, and who would own them) (e) Would the coffee consumers of Klamath Falls prefer to have fierce price competition, or would they prefer the less fierce price war?

Explanation / Answer

(a)
Dutch Bros best response to all of StarBucks actions are
Don't Enter for Enter StarBucks actions with Payoff (1,5)
Enter for Don't Enter StarBucks actions with Payoff (5,1)

StarBucks best response to all of Dutch Bros actions are
Don't Enter for Enter Dutch Bros actions with Payoff (5,1)
Enter for Don't Enter Dutch Bros actions with Payoff (1,5)

A Nash equilibrium exists where StarBucks best response is the same as Dutch Bros best response.
Thus the Nash Equlibrium are payoffs (1, 5) and (5,1)

(b)
Based on answer to (a), only one of the two firms Dutch Bros or StarBucks would enter the Klamath Falls.
There would be only one store and any of two firms would own them.

(c)
Dutch Bros best response to all of StarBucks actions are
Enter for Enter StarBucks actions with Payoff (2, 2)
Enter for Don't Enter StarBucks actions with Payoff (5,1)

StarBucks best response to all of Dutch Bros actions are
Enter for Enter Dutch Bros actions with Payoff (2, 2)
Enter for Don't Enter Dutch Bros actions with Payoff (1,5)

A Nash equilibrium exists where StarBucks best response is the same as Dutch Bros best response.
Thus the Nash Equlibria is payoff (2,2) where both firms enter the market.

(d)
Based on answer to (c), both firms Dutch Bros or StarBucks would enter the Klamath Falls.
There would be only two stores own by both firms Dutch Bros or StarBucks.

(e)
As, the profits of the firm now reduced from 5 million dollars to 2 million dollars in less fierce war. That means the coffee prices are lower in in less fierce war.
Thus the coffee consumers prefer less fierce price war.

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