3.4 Microsoft and Electronic Arts are separate companies.

Microsoft produces the Xbox One game console, and Electronic Arts creates games for the Xbox One. The two firms must independently decide on the amount to invest in two separate but complementary projects: Electronic Arts must decide how much to invest in the development of games for the next generation of the Xbox, and Microsoft must decide how much to invest in the development of the next generation of the Xbox game console. Each firm can invest a high amount, a medium amount, or a low amount. The game tree shows hypothetical profits of the two firms from different scenarios.

a. Suppose that the amount of Microsoft’s investment must be set first. What will the outcome be? Explain your answer.

b. Now suppose that Microsoft and Electronic Arts can sign a contract specifying the amount of each firm’s investment. Will the outcome differ from part a? If so, what will it be? Explain your answers.

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Accompanies problem 3.4. Electronic Arts Microsoft High invest Medium invest Electronic Arts Low invest Electronic Arts High invest Low invest High invest Low invest High invest Low invest Medium invest Medium invest Medium invest M: $800 M: $300 M: $200 M: $700 M: $600 M: $400 M: $650 M: $500 M: $300 EA: $700 EA: $800 EA: $600 EA: $400 EA: $650 EA: $500 EA: -$300 EA: $200 EA: $350