Part 1: Firm A currently monopolizes its market and earns a profit of $10 million. Firm B is a potential entrant that is thinking about entering the market. If B does not enter the market, it earns a profit of $0, while A continues to earn a profit of $10 million. If B enters, then A must choose between accommodating entry and fighting it. If A accommodates, then A earns $5 million and B earns $5 million. If A fights, then both firms lose $5 million.
Draw the game in extensive form and predict the outcome.
Part 2: Again, consider the above game. Now, suppose the decision of B to enter is reversible in the following way. After B enters the market and A has decided either to fight or accommodate, B can choose to remain in the market or exit. All payoffs from the above game remain the same. However, if B decides to exit the market, then B suffers a loss of $1 million, while A regains its old profits of $10 million. Draw the game in extensive form and predict the outcome.