Problem 2 (60 points total). Back in 2005, Sony and Toshiba tried to coordinate on a technology standard for high definition movies, both disks and players. Their failure to do so led to a 3-year battle that ended when Warner Bros. announced that it would support Blu-ray exclusively and Wal-Mart decided to stop carrying HD-DVD players. In the end, commentators said that while Sony won the battle, neither side exits this war with profitability. (Greenstein, Freakonomics Blog, March 4, 2008). Suppose that in 2005, the two companies had determined that this market was worth $400 million in net expected profits. (Specifically, they each expected that if they entered the market by themselves, they would earn profits of $700 million from the sales of both players and discs, minus a $300 million investment to develop and market the technology.) However, if they both entered the market with competing technologies, each firms revenue would be lowered by $300 million (due to cannibalization by the rival) and they would need to spend an extra $200 million each in marketing costs to try to convince studios to use their standard rather than their competitors. Finally, if either firm decided not to develop any new technology, it would earn $50M from its existing products, regardless of what its rival did.

a. (20 points) Summarize the information above in the boxes below (recall that in each cell, the number to the left of the comma is Sonys net payoff and the number to the right of the comma is Toshibas net payoff)

Toshiba: HD-DVD No new technology Sony: Blu-ray -100, -100 400, 50 No new technology 50, 400 50, 50

b. What is (are) the Nash equilibrium (equilibria) of this game, assuming that both players choose their actions simultaneously? Explain.

c. Is this game a prisoners dilemma? Why or why not?

d. Now suppose that because it had planned to include Blu-ray technology in its game console (the PlayStation 3), Sony had already incurred (sunk) $200M of the $300 development cost of its Blu-ray technology by the time the battle began. How would this affect the payoffs in the game or the Nash equilibrium (equilibria), if at all? Explain your answer