Find the best responses of each firm to each strategy of its rival.

In a country the market for electricity distribution is characterized as a natural monopoly. In other words, the demand for electricity is so small that only one firm can make positive net profits in the market. There are two firms, A and B, that consider entering in the market. The entry cost, i.e., the cost of building up capacity in order to start operation in the market, is equal to 200 thousands Euros. The total industry profits are equal to 300 thousands Euros and are divided equally between the two firms if both decide to enter.

a) The two firms decide simultaneously whether to enter or not in the market for electricity distribution. Represent the game in a matrix form.

b) Find the best responses of each firm to each strategy of its rival. Determine then the Nash equilibria of the game. Is there any way to predict which one of the two eqilibria will be played? Properly justify your answer.

c) Assume now that firm A can move first and decide between entering or not. Represent the game in a tree form and find its unique subgame perfect Nash equilibrium. Comment on your findings.

d) Suppose that firm B announces before firm A decides to enter or not, that it will enter the market anyway. Does this announcement change the outcome of the game? Discuss whether this announcement is credible or not.

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