Question

a) Explain the concepts of economies of scope and economies of scale. Discuss five clear reasons why we should believe that Kenya's Safaricom Ltd enjoys economies of scale and scope. (5 marks)

b) Consider a market with two competing firms whose objective is to increase profits by price changes. Each firm has two possible strategies i.e. either to maintain its prevailing price or increase it. If firm A maintains price, it will earn $40,000 if firm B also maintains its price (in which case firm B will earn $30,000); otherwise it will earn $48,000 if firm B increases price (in which case firm B's profits will only be $20,000). On the other hand, if firm A increases price and firm B maintains price, it will earn only $25,000 in profits, while firm B's profits increases to $48,000. However, if both firms pursue a price increase, profits will be $35,000 and $45,000 for firm A and firm B respectively.

Required:

i) Develop a payoff matrix for this decision-making problem. (4 Marks)

ii) In the absence of a binding and enforceable agreement, determine the pure strategy Nash Equilibrium. (4 Marks)

iii) From your result in (ii) above, does the game result in a prisoners' dilemma? Comment. (2 Marks)