Ford invites Clarion to set up a plant at Ford’s industrial complex in Brazil, where Clarion will build navigation systems for installation in the Ford cars produced there. If Clarion builds the plant, it would have no buyers for the plant’s output except Ford. If Clarion does not build the plant, neither firm benefits. If Clarion does build the plant, Ford considers paying three possible prices for the systems: p1 < p2 < p3. Price p1 is below Clarion’s aver-age variable cost, which implies that Clarion would produce nothing. Therefore, Clarion would be out of pocket for the cost of the plant, 100 (million), and Ford would get nothing. If Ford pays price p2, Clarion would more than cover its variable costs but still lose 90 and Ford would gain 140. At price p3, both firms would gain 25. Draw the game tree. What is the subgame-perfect Nash equilibrium? Specify a contract that would solve the potential holdup problem. Illustrate your solution in a new game tree and explain why it works.
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