Question

A flight route is served by American Airlines (AA) and Southwest Airlines (SW). Suppose American is the industry leader American will decide whether to raise airfares, and then Southwest will decide whether to match the price increase. What is the Nash equilibrium of the game?
a) The game does not have a Nash equilibrium.
b) American will leave fares unchanged and Southwest will leave fares unchanged
c) American will leave fares unchanged and Southwest will raise fares
d) American will raise fares and then Southwest will leave fares unchanged
e) American will raise fares and then Southwest will raise fares.

Answer 1

Answer:

The correct answer is b) American will leave fares unchanged and Southwest will leave fares unchanged.

Explanation:

The Nash Balance is a situation where individuals or players have no incentive to change their strategy taking into account the strategy of their opponents.

In the Nash equilibrium, the strategy chosen by each participant of a conflict or game is optimal, given the strategy chosen by the others. In other words, nobody will gain anything if they decide to change their strategy under the assumption that the other individuals do not change theirs.

It should be noted that under the Nash equilibrium the greatest gain is not necessarily obtained for all individuals or players as a whole. It is only true that each responds optimally to the strategy of others. In many cases, individuals would like to be able to reach another balance with higher profits but fail to do so because they face the risk of being betrayed.