HCS’s 500-tonne Geleen plant is not being built at the most efficient scale. Despite HSC’s public propaganda about a potentially more efficient process, HSC’s internal operations group estimates a variable cost of 25 USD per pound if the 500-tonne plant is run at full capacity. They estimate a variable cost of 23 USD per pound if the 1000-tonne plant is run at full capacity. As the ground has not yet broken on the Geleen site, the cost of increasing the plant’s capacity to 1000 tonnes per year is currently trivial. However, once construction is completed, the cost of adding the capacity will be prohibitively expensive.

Vermijs believes NutraSweet will follow one of two basic strategies: Price War or Acquiesce. Under the Price War Strategy, NutraSweet will price at HSC variable cost. As such, HSC will not produce. Under the Acquiesce Strategy, NutraSweet will not fight a price war and will allow HSC’s output to enter the European and Canadian markets. It is assumed that natural competition would then drop the price to 50 USD per pound in both markets. In this case, HSC will produce to full capacity. (Note: HSC analysts believe the 50 USD per pound price will hold irrespective of whether HSC makes 1000 tonnes per year or 500 tonnes per year.) Despite the data, assume that the Canadian and European markets will consume 1100 tonnes per year, irrespective of price. Further assume that NutraSweet has a variable cost of 18, irrespective of what sized plant HSC builds. Also assume that if NutraSweet acquiesces, HSC sells all its output. If NutraSweet fights a price war, HSC sells none of its output. In either case, the US market does not increase to absorb NutraSweet’s lost European sales.

1) Ignoring fixed costs, construct a 2x2 normal form game payoff matrix showing NutraSweet’s and HSC’s payoffs under the following situations. (Note: Despite the normal form layout, in this game, HSC first decides what size plant to build, and NutraSweet then decides whether or not to fight a price war.)

		Nutrasweet
		Price war	Acquiesce
HSC	500 tonne plant
	1000 tonne plant

HW PART 2: In four sentences or less, tell me what sized plant HSC should build and why.