Facing a potential entry, an incumbent can set its price either below entrant's cost (limit pricing) or
Question:
Facing a potential entry, an incumbent can set its price either below entrant's cost ("limit pricing") or above entrant's cost ("normal pricing"). If the incumbent implements the limit pricing and the entrant enters, the incumbent's profit is $350 and the entrant's profit is -$100. If the entrant does not enter under the limit pricing, the incumbent gets the profit of $450 and the entrant gets a zero profit. On the other hand, if the incumbent implements the normal pricing and the entrant enters, both firms get $200 each. If the entrant does not enter under the normal pricing, the incumbent gets the profit of $700 and the entrant gets a zero profit. Draw an extensive form of this dynamic game in which the incumbent moves first, and find the subgame perfect Nash equilibrium. If the entrant wants to induce the incumbent to allow entry by implementing the normal pricing, how much should the entrant pay to the incumbent? Will the entrant pay this amount to the incumbent?