To increase its market share, one firm in a duopoly has been charging a price less than its competitor. This has reduced the other firm's profits, and that second firm is now threatening the first with a price war. If the first firm does not raise its price, the second one will lower its price to undercut the price presently being charged by the first firm. Should the first firm consider the threat credible and raise its price? The table below shows the profits each firm would make on the various possible outcomes.

a. Draw the game tree. Who moves first?

b. What is the equilibrium?

c. Should Firm 1 believe Firm 2's threat is credible?

d. What action does Firm 1 take?

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Firm 1 Firm 2 Profit Market Share Profit Raise price, no retalia- tory price cut 90 50% 90 Raise price, retaliatory price cut 77 43% 86 Do not raise price, no retaliatory price cut 88 55% 81 Do not raise price, retaliatory price cut 76 48% 79