Firm A is considering entering a market in which firm B is a monopolist. Firm B must decide how to respond to this challenge. If firm A decides to enter, firm B can either adopt an aggressive pricing strategy or a passive pricing strategy. If firm B adopts an aggressive pricing strategy, firm A will lose $5 million, although firm B will only earn $1 million. If firm B adopts a passive pricing strategy, firm A will earn $3 million and firm B will earn $7 million. Finally, if firm A decides to stay out of the market, firm B will earn $14 million regardless of its pricing strategy. The Nash equilibrium strategy profile for this game is:
A) {Enter, Aggressive}.
B) {Enter, Passive}.
C) {Stay out, Aggressive}.
D) {Stay out, Passive}.
E) Undecided. This game has multiple Nash equilibria.

Question

Quizplus · Accepted Answer

Given the options, Firm A will decide to enter because its best outcome occurs when entering, regardless of Firm B's strategy (losing $5 million is better than not entering at all, and earning $3 million is obviously preferable). Knowing this, Firm B's best response to Firm A's entry is to adopt a passive strategy, as it earns more ($7 million) compared to an aggressive strategy ($1 million). Thus, the Nash equilibrium is {Enter, Passive}, where Firm A enters and Firm B adopts a passive pricing strategy.

Firm a Is Considering Entering a Market in Which Firm