(See attached file for full problem description)
The market for commercial aircraft is dominated by two firms, Airbus (player A) and Boeing (player B). A crucial decision for each firm is that of introducing a new aircraft model. Let N (for "new") denote the strategy of introducing new models and let O (for "old") be that of staying with the current model line. The profits of each firm are described in the payoff matrix below. In answering the question, you must focus on the payoff numbers as they are given and develop your argument based on these numbers.
Firm A N 40, 40 75, 20
O 20, 75 50, 50
a. Explain the incentives of each firm for introducing new models in this market. Be
sure to point out any outcomes with a "collusive" structure.
b. Which outcomes constitute a Nash Equilibrium? In what sense are these stable outcomes?
c. Now suppose that Firms A and B compete with each other period after period on an ongoing basis. After each period, each firm can observe whether the other has introduced a new model or not. Consider the two factors of i) repeated play and ii) observable choices and explain how each factor influences the ability of the firms to support a collusive outcome.
You may, if you wish, frame your answer in terms of a "proposal" or "strategy recommendation" to the firms, and then describe how i) and ii) above relate to your proposal.
a. From the table, it's clear that, if this is a one-shot game, no matter what the other firm does, the best strategy for a firm is to introduce new models. Consider firm A. If firm B introduces new models (first column), then clearly firm A has an incentive to introduce new models too, because the payoff is 40 if it does, as opposed to 20 if it keeps its current models (intuitively, we could think that if firm B becomes more advanced technologically, then firm A must keep up or be shaken off the market). Let's now consider the opposite case, in which firm B keeps the current models (second column). Again, firm A has an incentive to introduce new models, because the payoff is 75, against 50 if it doesn't (intuitively, if firm B stays behind technologically, then firm A has an incentive to gain a larger portion of the market by offering new products). The same reasoning can be used from firm B's point of view.
Thus, in a one-shot game with no collusion, the best strategy for any firm is to design and introduce new ...
Which outcomes constitute a Nash Equilibrium? In what sense are these stable outcomes?