Two airlines, Dragon Airline and Phoenix Airline, provide direct flight service to a city and tend to compete for the same group of travellers. They are contemplating changing their airfares to earn more profit. If both airlines raise their airfares, Dragon Airline will earn $800m while Phoenix Airline will earn $400m in profit. If both airlines reduce their airfares, Dragon Airline will earn $650m while Phoenix Airline will earn $550m in profit. If Dragon Airline raises its airfare while Phoenix Airline reduces its airfare, Dragon Airline will earn $200m while Phoenix Airline will earn $350m in profit. If Dragon Airline reduces its airfare while Phoenix Airline raises its airfare, Dragon Airline will earn $300m while Phoenix Airline will earn $250m in profit. Construct the payoff matrix in terms of profit for the two pricing strategies. Apply a game theory concept and solve this game using the Nash equilibrium method. Explain how you derive your answers and also whether this game is a prisoner's dilemma game. How will your answer be different if the game become a sequential game and Phoenix Airline gets to move first? Explain your answers by constructing a suitable decision tree diagram, employ the roll back method to solve the sequential game.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Two airlines, Dragon Airline and Phoenix Airline, provide direct flight service to a city and tend to compete for the same group of travellers. They are contemplating changing their airfares to earn more profit. If both airlines raise their airfares, Dragon Airline will earn $800m while Phoenix Airline will earn $400m in profit. If both airlines reduce their airfares, Dragon Airline will earn $650m while Phoenix Airline will earn $550m in profit. If Dragon Airline raises its airfare while Phoenix Airline reduces its airfare, Dragon Airline will earn $200m while Phoenix Airline will earn $350m in profit. If Dragon Airline reduces its airfare while Phoenix Airline raises its airfare, Dragon Airline will earn $300m while Phoenix Airline will earn $250m in profit. Construct the payoff matrix in terms of profit for the two pricing strategies. Apply a game theory concept and solve this game using the Nash equilibrium method. Explain how you derive your answers and also whether this game is a prisoner's dilemma game. How will your answer be different if the game become a sequential game and Phoenix Airline gets to move first? Explain your answers by constructing a suitable decision tree diagram, employ the roll back method to solve the sequential game.

Definition Definition Economic decision-making framework that analyzes how different players optimize their outcomes with given pay-offs corresponding to their available strategies. The assumptions of game theory are: The number of players or competitors are finite/limited; All participants are rational The rules of the game are known to every player; and Each participant has a finite set of actions. A common way in which game theory is presented as an ( m x n ) matrix in which m represents the strategies of row player and n represents the strategies of column player. There are several limitations of game theory: Many businesses have a large number of competitors, and selecting an optimal strategy in these circumstances is difficult; Real-life business operating environments are full of uncertainty and difficult to model as a game theory; and The assumption of rationality and utility maximization isn't always an accurate portrayal of human nature.

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