Question

Consider an industry with two firms. Each firm can spend either 0, $1, or $4 on a lobbying effort. Call the amount spent by Firm i, L_i. Now, regardless of their lobbying effort, each firm gets an identical subsidy having present value . (This subsidy depends on both the total lobbying effort and on how widespread it is.)

Treating it as a 2-player game, construct a 3 × 3 diagram showing the net payoffs of each firm.

Find all Nash equilibria for the game.

(1 mark) Which is the most likely outcome? Why?

Answer 1

a)

		Firm 2
		0	1	4
Firm1	0	0,0	1 , 1	2, 2
	1	1, 1	3, 3	5, 5
	4	2, 2	5, 5	8, 8

b) BR1(0) : Best response of firm 1 to firm 2 choosing 0

BR1(0) ={4}

BR1(1) = {4}

BR1(4) = {4}

BR2(0) ={4}

BR2(1) = {4}

BR2(4) = {4}

Thus the firms have $4 as their dominant strategy.

Nash equilibrium is {4, 4}: Both firms choose $4.

c) Most likely outcome is the two firms choosing maximum to exert lobbying effort because this is a simultaneous move game and therefore both firms will choose best they can do .