Suppose the iPad made by Apple is the only tablet on the market and Amazon are considering entering the market for tablets with their own product. If Amazon does not enter the market Apple will earn profits of €2 billion. If Amazon does enter the market, Apple faces a choice of cutting its prices or not. If Apple cuts its prices its profits will fall to €0.8 billion and Amazon will lose €0.5 billion. If Apple does not cut its prices, it will earn profits of €1 billion while Amazon will earn profits of €0.5 billion.
a. Set up the extensive form (decision tree) of this game.
b. Apple hears that Amazon is considering entering the market and announces that it will cut its prices. Is this threat credible? Should Amazon enter this market? Explain your reasoning carefully.
c. Suppose that Apple builds excess capacity. It becomes less operationally efficient because of this. As a monopolist it makes profits of €1.2 billion. If Amazon enters and Apple cuts its prices then Apple makes profits of €0.6 billion. If Amazon enters and Apple does not cut prices then Apple makes profits of €0.5 billion. All the other payoffs remain unchanged. Write out and solve the extensive form of the game under this scenario. How does this outcome compare with the outcome in the first version of the scenario?