Question: 1. Determine the potential rivals response in the second stage to each possible action taken by the incumbent in the first stage. To solve for

1. Determine the potential rival’s response in the second stage to each possible action taken by the incumbent in the first stage. To solve for the subgame perfect Nash equilibrium, we work backwards from the potential rival’s entry decision in the second stage of the game. If the incumbent does not invest, its rival enters because its profit from entering, r = 4, exceeds its zero profit if it does not enter. If the incumbent does invest, its potential rival stays out of the market because entry would be unprofitable: r = -1 6 0.

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