I'm reposting this as I did not receive a response.

Posted by Dwane on Wednesday, November 22, 2006 at 1:23pm.

I pasted the problem I am to solve below. I missed the first week of class, so the professor told me to do this case as a make-up assignment; however, we are not covering this chapter and I'm confused! My professor did tell me that I need to use the bimatrix game theory and input the data to find the answer. I don't know what in the world to do! See below. Please help!

Memo 7
To: Pricing Manager, District 6SW
From: Vice President, Marketing
Re: Strategic Pricing Decision

Our only competitor in District 6SW currently provides bundled services at $84.95. We are
currently charging a 10% premium over their price, but there are unsubstantiated rumors that
they are contemplating a 10% price increase. We don’t know their cost structure, so we don’t
know whether their potential price increase is driven by cost increases or is merely a strategic
move on their part.

Historically, when we both charge the same price, our market share is about 65%. When we
charge a 10 percent premium over their price, our market share declines to about 60%. It
appears that in those instances where they have charged a 10% premium over our price, our
market share is about 70%.

Please provide a recommendation regarding whether we should maintain our current price or
reduce our price to $84.95. Please factor into your recommendation that we pay
programming fees to providers that amount to $32.50 for each subscriber. In addition,
maintenance, service and billing costs are about $7.60 per subscriber. At present, there are
about 110,000 households in the relevant area.

Tough problem. Its been years since I have had to "solve" game-theory problems.

I can tell you where to start. First do some research on game theory, especially on "Nash Equilibrium" and "Prisoner Dilemma". Google is the place to start.

Next, fill in a 2x2 matrix. Lable the rows "Us", lable the columns "Them". Lable row 1 "Stay", and row 2 "down 10%". Lable column 1 "Stay", column 2 "up 10%" -- You get the idea. Then calculate the expected profit under the four scenarios.

Next is the hard part -- calculating the position of the competitors. I suggest you calculate their profits under the 4 scenarios but under two possible states; a) they have the same cost structures, or b) their costs are 10% higher. Then look for the Nash Equilibrium conditions under the two states.

Lotsa luck.

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