Little Kona is a small coffee company that is considering entering a market dominated by Big Brew. Each company’s profit depends on whether Little Kona enters and whether Big Brew sets a high price or low price:

If Little Kona does not enter then Big Brew will gain payoff of $7 million if they charge a high price and $2 million if they charge a low price.

If Little Kona enters and Big Brew charges a low price both firms will earn a payoff of $1 million.

If little Kona enters and Big Brew charges a high price Little Kona will earn $2 million while Big Brew earns $3 million.

Copy the following payoff matrix and fill in the payoffs:              

                                                                            Big Brew

	High Price	Low Price
Enter
Don’t Enter

              

What is the Nash equilibrium in this game?  

Big Brew threatens Little Kona by saying “If you enter, we’re going to set a low price, so you have better stay out.” Do you think Little Kona should believe the threat? Explain. 

 If the two firms collude and agree on how to split the total profits, what outcome would they pick? Explain.