Question

4. The Windows operating system from Microsoft, Inc. runs about 90% of the world’s personal computers, so it is natural to think that Microsoft has a monopoly in the market for operating systems. According to economist Richard Schmalensee, an expert on oligopoly and monopoly, Microsoft’s profit-maximizing monopoly price is between $900 and $2,000. That’s the amount Microsoft would charge if it acted like a regular monopolist. However, Microsoft has tended to charge only $99 for Windows. Perhaps Microsoft is an insecure monopolist and picks a low price to discourage entry and preserve its monopoly. In other words, if Microsoft charged $2,000 for its operating system, there would be an incentive for other firms to develop alternative operating systems.

Suppose that the market for operating systems is initially a monopoly (Microsoft is the monopoly) with the potential for a second firm to enter the industry. Suppose Microsoft can charge a price of either $99 or $900 for its operating system. Suppose a new firm namely, Mac OS X has three options: enter the industry and charge $99, enter the industry and charge $900, and not enter in the industry. The profits that would result from these outcomes are presented in a payoff matrix below.

		Microsoft (M)
		P = $99	P = $900
Mac OS X (NF)	Enter, P = $99	M = 5 NF = 5	M = 0 NF = 10
	Enter, P = $900	M = 10 NF = 0	M = 50 NF = 50
	No Entry	M = 10 NF = 0	M = 100 NF = 0

Assume that Microsoft and the Mac OS X move simultaneously.

a) Does Microsoft have a dominant strategy? If so, what is it?

b) Does the Mac OS X have a dominant strategy? If so, what is it?

c) Find all Nash Equilibria for this game.

Now assume that Microsoft moves first and that the Mac OS X moves second.

d) Find the Stackelberg Equilibrium to a sequential-move game

Answer 1

Answer for a)

Microsoft has no Dominating strategy but

Mac OS X has dominating strategy of Enter at P=$99 and P=$999 and dominated strategy is No Entry

WE have 2 nash Equilibria in this game

(Enter P=$99,Enter P=$99) & (Enter P=$999,Enter P=$999)

Stackelberg equilibrium is First mover advantage equilibrium

If Microsfot (M) moves first then it knows that Microsoft will have highest payoff of 50 and of 5 otherise

therefore only 1 SPNE of (50,50) gets activated

Stackelberg Equilibrium is (Enter P=$999,Enter P=$999)