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game theory analysis of detering a new entrant into a market

Maytag wants to prevent Whirlpool from entering the market for high priced, front load washing machines. Front load washing machines clean clothes better and use less water than conventional top load machines. Even though front load machines are more costly to manufacture than top loaders, Maytag is nonetheless earning economic profit as the only firm making front loaders for upscale consumers. The following table show the annual profits (in millions of dollars) for Maytag and Whirlpool for the pricing and entry decisions facing the two firms.

(see attached document)

a) Can Maytag deter Whirlpool from entering the market for front load washing machines by threatening to lower price to $500 if Whilrpool enters the market? Why or why not?

Suppose the manager of Maytag decides to make an investment in extra production capacity before Whirlpool makes its entry decision. The extra capacity raises Maytag's total costs of production but lowers its marginal costs of producing extra front load machines. The payoff table after this investment in extra production capacity is shown here:

(see attached document)

b) Can Maytag deter Whirlpool from entering the profitable market for front load washing machines? What must be true about the investment in extra production capacity in order for the strategic move to be successful? Explain.

c) Construct the sequential game tree when Maytag makes the first move by deciding whether to invest in extra production capacity. Use the roll back technique to find the Nash equilibrium path. How much profit does each firm earn? (Hint: the game tree will have three sequential decisions: Maytag decides first whether to invest in extra plant capacity, Whilrpool decides whether to enter, and Maytag makes its pricing decision.)


Solution Preview

17a) The question involves determining whether Maytag's threat is credible. Suppose Whirlpool does enter the market, Maytag would be best off pricing at $1000, hence Maytag's threat is not credible. Maytag's ...

Solution Summary

This problem uses game theory to examine whether a threat to deter entry of a firm into a market is credible and what the outcome of such a game would be. Additionally, it considers the case when the incumbent builds excess capacity to make the threat credible. Finally, I provide a game tree and demonstrate the process of backward induction to find an equilibrium.