Homework 5, Entry Deterrence
Samsung wants to prevent Whirlpool from entering the market for high-priced, front-load washing machines. Front-load washing machines clean cloths better and use less water than conventional top-load machines. Even though front-load machines are more costly to manufacture than top-loaders, Samsung is nonetheless earning economic profit as the only firm making front-loaders for upscale consumers. The following payoff table shows the annual profits (in millions of dollars) for Samsung and Whirlpool for the pricing and entry decisions facing the two firms.
Whirlpool P = $500 P = $1,000
Stay out $0, $20 $0, $34
Enter -$5, $15 $17, $17
a. Can Samsung deter Whirlpool from entering the market for front-load washing machines by threatening to lower price to $500 if Whirlpool enters the market? Why or why not?
Suppose the manager of Samsung decides to make an investment in extra production capacity before Whirlpool makes its entry decision. The extra capacity raises Samsung’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:
Whirlpool P = $500 P = $1,000
Stay out $0, $16 $0, $24
Enter -$6, $14 $12, $12
b. Can Samsung 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 Samsung 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: Samsung decides first whether to invest in extra plant capacity, Whirlpool decides whether to enter, and Samsung makes its pricing decision.)
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