Figure 12.4

Rainbow Writer (RW)is a small online company selling a highly rated software package for printing color labels directly onto CDs. The firm currently earns a profit of $2 million per year selling its package exclusively on its Web site. Odeon, the producer of the most popular software package for editing and burning CDs and DVDs, has expressed interest in bundling Rainbow Writer's product into its own package. Odeon expects that bundling would further boost its sales and allow it to sell the new bundled product at a higher price, thus raising its profits beyond its current profit of $12 million. Figure 12.4 shows the decision tree for the Rainbow Writer-Odeon bargaining game.
-Refer to Figure 12.4.What is the equilibrium outcome in this game and is this a subgame-perfect equilibrium?

Question

Figure 12.4
  
Rainbow Writer (RW)is a small online company selling a highly rated software package for printing color labels directly onto CDs. The firm currently earns a profit of $2 million per year selling its package exclusively on its Web site. Odeon, the producer of the most popular software package for editing and burning CDs and DVDs, has expressed interest in bundling Rainbow Writer's product into its own package. Odeon expects that bundling would further boost its sales and allow it to sell the new bundled product at a higher price, thus raising its profits beyond its current profit of $12 million. Figure 12.4 shows the decision tree for the Rainbow Writer-Odeon bargaining game.
-Refer to Figure 12.4.What is the equilibrium outcome in this game and is this a subgame-perfect equilibrium?

Quizplus · Accepted Answer

In the equilibrium, either offer of $30 or $40 per copy of the software package is accepted and these two equilibria are subgame-perfect equilibria. This is because both players have no incentive to deviate from their chosen strategies even if they have the opportunity to make a new decision at a subgame. If Rainbow Writer accepts Odeon's offer of $30, it earns a profit of $16 million ($14 million from selling the software and $2 million from its own profits). If Rainbow Writer rejects Odeon's offer of $30 and Odeon offers $40, Rainbow Writer earns a profit of $10 million ($8 million from selling the software and $2 million from its own profits). Odeon earns a profit of $20 million from selling the bundled product in both cases, which is higher than its current profit of $12 million. Therefore, either offer of $30 or $40 per copy of the software package is a reasonable choice for Rainbow Writer.

Figure 12.4 Rainbow Writer (RW)is a Small Online Company Selling a Highly