However in determining mr there is an important

This preview shows 12 out of 13 pages.

MC. However, in determining MR, there is an important difference related to how the output of the other firm is treated. State this difference and explain why it makes sense. (4 pts). 3. Consider a game in the Canadian airline industry. A particular route is currently served by incumbent Air Canada (AC). WestJet (WJ) is considering entering the route. If WJ enters AC has two possible strategies at its disposal: Fight the entry, or Accommodate (the entrant). WJ has the option to enter or not enter the route. Dollar numbers are in thousands of dollars per week. In the absence of competition, AC makes monopoly profits of 150. If WJ enters and AC accommodates (by maintaining price and sharing the market), then AC earns 100 and WJ earns 80. If WJ enters and AC decides to fight, then AC makes 70 and WJ suffers a loss of 20. a) Construct a game tree representing this situation and indicate clearly the outcome predicted by game theory. (4 pts)
Image of page 12

Subscribe to view the full document.

11 b) Now assume that to deter entry, AC buys an additional aircraft and threatens WJ with a price war in case of entry. This new purchase reduces AC's profits by 40 in all situations except when it fights the entry. Assuming that WJ can foresee this situation before it makes its entry decision, redraw the game tree for this new situation and identify the sequential Nash equilibrium outcome. Use your results from parts (a) and (b) to briefly explain the statement: “commitment makes a threat credible”. (7 pts) c) Suppose AC hears a rumor that WJ likes to take on risk and will enter the market with probability p even if it is not profitable to do so. However, WJ will always enter if it can profit from doing so. For what range of values of p will AC not invest in the additional fleet and thus not threaten a price war? (4 pts) 4. A manager must choose one of four advertising strategies, with the following characteristics. Strategy Return with Bad Luck Probability of Bad Luck Return with Good Luck Probability of Good Luck A 3 0.7 10 0.3 B 4 0.6 7 0.4 C 1 0.2 6 0.8 D 2 0.5 10 0.5 a) Calculate the expected return and the standard deviation of the return for each of the four strategies. (Use a spreadsheet for these calculations). (4 pts) b) Assume the decision maker cares only about the expected value and about the risk as measured by variance (or standard deviation) and is risk averse. Can you say which project would be chosen? Can we eliminate any of the projects from consideration? Explain briefly. (4 pts) c) Now suppose you are told that the decision maker is risk averse and has a utility function over income with the following values: U(0) = 0; U(2) = 6; U(6) = 12; U(10) = 14. You are also told that the utility function is a smooth function. Draw a diagram illustrating the utility function by showing the four points just given and then connecting these points. Also show the risk premium associated with strategy D. You will not be able to calculate this risk premium. Just show it on the diagram. Put numerical values on the axes corresponding to the information given. Determine the expected utility associated with Strategy D and show it on the diagram (7 pts)
Image of page 13
You've reached the end of this preview.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern