Managerial Economics & Organizational Architecture 6th Edition by James Brickley , Clifford Smith ,Jerold Zimmerman

Exercise 12

Formulate the following situation as an extensive form game (using a game tree) and solve it using backward induction. Bingo Corporation and Canal Corporation are the only competitors in the electronic organizer industry. Bingo Corporation is considering an R D investment to improve its product. Bingo can choose from three levels of investment: High, Medium, and Low. Following Bingo's investment, Canal Corporation will have to choose between continuing to compete by selling its current product or undertaking an R D project of its own. Canal can only choose one level of investment, so its choices are Invest or Not Invest. The net payoffs to Bingo if it invests High, Medium, or Low given that Canal chooses to Invest would be $50, $40, and $30, respectively, and the corresponding net payoffs to Canal would be $5, $10, and $15. On the other hand, the net payoffs to Bingo if it invests High, Medium, or Low given that Canal chooses to Not Invest would be $100, $80, and $60, respectively, and the corresponding net payoffs to Canal would be $0, $15, and $20. What will Bingo choose to do in equilibrium, and what will Canal's response be
This game can be expressed in extensive form (as a game tree) as follows: