Q13 is uploaded

[Cat Moisanu]

Parts a and b are basically straight out of the textbook/notes. Part c I'm not 100% sure about. I will try to probe prof in class and update if I find out anything different. 

Cat

[Mike Dickin]

I am having difficulty uploading my PDF solution for Q#13 to the bank.
So, I will post the answers here:



Question #13
a) A strategic effect is the response of an organization and their
rival(s) to a strategic decision made by that organization. Sunk
costs, irreversibility and commitment affect the strategic effect of
the decision in that the higher the sunk costs, the less reversible
the decision will be and the more committed the company will have to
be to their strategic decision. For example, if a company makes a
decision to lower production costs, and thus sale prices, by investing
in technology to automate some or all of the production process, then
the costs that are sunk into the purchase of the technology make the
decision highly irreversible. Rival firms may realize this and govern
themselves accordingly (match lower prices, maintain current prices,
raise prices, exit). A negative strategic response occurs when a
strategic decision induces a tough response from rivals, which results
in profit reduction for the firm making the strategic decision. A
positive strategic response occurs when a strategic decision induces a
soft response from rivals, which results in profit increase for the
firm making the strategic decision.
b) If a firm invests in R&D to improve the quality of their product, a
positive strategic effect is likely to occur if the competition
becomes aware. If one firm improves its product quality, this will
create vertical differentiation in the market and in a price
competitive market. This will allow the firm to increase prices
irrespective of firms with lower quality goods. However, buyers must
be able to judge quality. Once rival firms become aware of the
improvements, they are likely to mimic these improvements, which will
again put them into competition and ultimately drive prices back
towards marginal costs.
c) The strategic effect of two airlines forming an implicit agreement
to price collusively for common routes will likely be negative for
these firms. Pricing collusively will allow the two airlines to
attempt monopoly pricing, however smaller firms who are not part of
this agreement will then have incentive to undercut the monopoly
price. Whether smaller firms are motivated to do this will depend on
their pricing structure. If their marginal costs are lower than the
allied airlines then they will be somewhat insulated from punishment.
However, if the allied airlines have the ability to cut prices to a
level that is below the smaller firm’s marginal costs, they may wish
to view the allied airlines as price leaders and stay in line with
these prices. In the current airline industry, it is likely that the
strategic effect will be negative due to the number of smaller
airlines, who have less to lose from inciting a price war.