Question

13. Podunk City has two coffee shops and everyone in the city buys one cup of coffee per day. The owners of these shops can serve Maxwell House Coffee or they can serve Le Fru FruGourmet Coffee (simplifying assumption—suppose they charge the same price for either cup of coffee). Assume that customers strictly prefer Le Fru Fru coffee so that if one firm offers Le Fru Fru and the other doesn’t, all customers will go to the Fru Fru shop (the other shop earns 0 profits). When both firms offer Maxwell House, each firm makes $30 profit each period. Changing to Le Fru Fru coffee increases a firm’s costs by $10 each period so if they both sell Le Fru Fru, both make $20 profit.

a) Draw a payoff matrix associated with this game. (1 pts)

b) What is the Nash equilibrium outcome? (1 pt)

c) If these two firms could act as a cartel, which coffee type would they both agree to sell? (1 pt)

Answer 1

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