Problem:
Consider two strategically dependent firms in an oligopolistic industry: Firm A and Firm B. Firm A knows that if it offers extended warranties on its products but Firm B does not, it will earn $6 million in profits, and Firm B will earn $2 million. Likewise, Firm B knows that if it offers extended warranties but Firm A does not, it will earn $ 6 million in profit, and Firm A will earn $2 million. The two firms know that if they both offer extended warranties on their products, each will earn $3 million in profits. Finally, the two firms know that if neither offers extended warranties, each will earn $5 million in profits.
1. Create a pay off matrix that fits the situation faced by the two firms.
2. What is the dominant strategy in this situation? Explain.