In 1960 Coca-Cola introduced Sprite, which today is the worldwide leader in the lemon-lime soft drink market and ranks fourth among all soft drinks worldwide. Prior to 1999, PepsiCo did not have a product that competed directly against Sprite and was trying to decide whether to introduce such a soft drink. The 1999 annual profits for PepsiCo were $200 million profit and total annual profits at Coca-Cola were $300 million.

If PepsiCo introduced a new lemon-line soft drink, Coca-Cola could purse one of two possible strategies:

(1) PepsiCo could trigger a price war with Coca-Cola in both lemon-lime and cola markets, with resulting annual profits declining to $100 million for each firm.

(2) Coca-Cola could acquiesce. The net effect of an acquiescence strategy would result in Coca-Cola and PepsiCo earning total profits of $275 million and $227 million, respectively.

Part 1: Diagram this situation using the extensive or tree-form of a game and identify the Nash Equilibrium

Part 2: If you were a manager of PepsiCo, would you try to convince your colleagues that introducing the new soft drink is the most profitable strategy? Why or why not?

Part 3: Let "p" represent the probability that Coke engages in a price war.What is the break-even probability "p" for which Pepsi's expected profit from introducing Sprite exceeds Pepsi's profit from not introducing Sprite?