Pricing Games: Sony PlayStation and Microsoft Xbox Case Study #2

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Case Study #2: “Pricing Games: Sony PlayStation and Microsoft Xbox” (Due Date: April 4 at 6:30PM) Name: TJ Question 1: Given the information in Exhibits 1, 2, and 3 and assuming that collusion does not occur, would you predict that Sony and/or Microsoft will want to reduce console prices by $100?

Complete the payoff matrix below to analyze this two-player simultaneous game by (1) replacing the player names with the names of the firms, (2) appropriately renaming the players’ strategies, and (3) calculating the payoffs for each player in the four possible outcomes. You can assume Nintendo monitors its competitors’ actions, but has no plans to change its price. (5 points) Answer 1:

Player 1

Player 2 Strategy 1 Strategy 2 Strategy 1 $A , $B $A , $B Strategy 2 $A , $B $A , $B

Microsoft-XBOX Don't Reduce Price -399 SonyPlayStation

PS3 Price 299 299 399 399 XBox360 Price 299 399 299 399

Reduce Price -299

Don't Reduce Price-399

$482.48 ,

$510.00

$217.22,

$562.50

Reduce Price-299

$636.73,

$186.97

$428.74,

$470.01

Ps3 Sold

Per Unit Total Cost

Profit

Attain

11.25 11.75 8.25 8.75 XBOX 360 Sold 11.5 7 12.5 8

260.89 244.81 372.67 343.86 Per Unit Total Cost 258.13 372.29 254 335.25

38.11 54.19 26.33 55.14 Profit 40.87 26.71 45 63.75

428.74 636.73 217.22 482.48 Attain 470.01 186.97 562.50 510.00

Based on the calculation, when Sony and Microsoft reduce their prices for their console by $100.00 resulted in higher profit. I believe that both organizations lower their prices so they can

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attain comparable earnings for foreseeable future.

Question 2: Assume the demand curves implied by the data in Exhibit 1 are linear. How many units of PS3 and Xbox 360 will Sony and Microsoft sell, respectively, if they both charged $399?

How many units will each firm sell if they both charged $299? Use your answers to calculate the arc price elasticities of demand for Sony and Microsoft if they both initially charged $399 then both dropped their price to $299. Based on your arc price elasticity of demand calculations, would you recommend Sony to increase or decrease its price for PS3 if Sony solely wanted to increase total revenue? Would you make the same price recommendation to Microsoft if it was solely interested in increasing total revenue? (5 points) Answer 2: .

Q 1 P 1 Q 2 P 2

Step 1: Change in 8.25 Quantity $399. Step 2: Average 00 Quantity 11.25 Step 3: %ΔQ $299. Step 4: Change in 00 Price Step 5: Average Price Step 6: %ΔP Step 7: eP

Sony Q 1 8.75 P $399.

1 00 Q 2 11.75 P 2

Step 1: Change in Quantity Step 2: Average Quantity Step 3: %ΔQ

$299. Step 4: Change in 00 Price Step 5: Average Price Step 6: %ΔP Step 7: eP

Microsoft Q Step 1: Change in 1 7.00 Quantity P $399. Step 2: Average

3.00 10 0.308 $100.

00 $349.

00 -0.287 -1.07

3.00 10 0.293 $100.

00 $349.

00 -0.287 -1.02

4.50 9

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1 Q 2

00 Quantity 11.50 Step 3: %ΔQ

P 2

$299. Step 4: Change in 00 Price Step 5: Average Price Step 6: %ΔP Step 7: eP

Microsoft Q 1 8.00 P $399.

1 00 Q 2 12.50 P 2

Step 1: Change in Quantity Step 2: Average Quantity Step 3: %ΔQ

$299. Step 4: Change in 00 Price Step 5: Average Price Step 6: %ΔP Step 7: eP

0.486 $100.

00 $349.

00 -0.287 -1.70

4.50 10 0.439 $100.

00 $349.

00 -0.287 -1.53

Both Sony and Microsoft are elastic %ΔQ > %ΔP and in competitive market. Also to maximize the profit, the both companies needs to lower the prices of their console to increase in the total revenue and sales of unit.

Question 3: Assuming that Sony and Microsoft do not collude, can you think of reasons why these firms would be particularly aggressive in pricing their consoles? Be sure to discuss the concept of dominant strategies in your answer. (5 points) Answer 3: Sony and Microsoft both dominated the market share of the gaming console worldwide. The production cost per units including distribution are very high and to the dominate the market both firms are aggressive in pricing their consoles. Also, each company set up the best prices strategy regardless what other firm does. If both firms have a dominated strategy is not to reduce

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prices on their consoles, then both companies able to make almost comparable income. However, if projected number of units sold in the market are fewer than expected, then firms will shift dominate strategy by reducing prices on their consoles. Furthermore, there are not that many competitors in the game market other than Sony and Microsoft, which forces them to reevaluate their prices as compare to other products.

Question 4: Suppose that Sir Howard Stringer, Sony’s CEO in 2009, and Steve Ballmer, Microsoft’s CEO in 2009, communicated a mutual interest in colluding with each other. Which pair of strategies are they likely to agree on? How would this type of behavior violate antitrust laws? Other than this antitrust legal issue, why would this outcome not be a Nash equilibrium if they did not collude? (5 points) Answer 4: If both Sony and Microsoft agrees and successfully enter into an agreement in mutual interest on various factors such as prices, market shares, etc. will create explicit collusion. Also, they can achieve long-run economic profit similar to monopoly. The explicit collusion or cartel agreement is illegal by the US government, and they enforce by creating antitrust laws. Furthermore, explicit collusion helps firms not to compete, and control the production or manufacturing of their product to raise or fall their prices to earn higher profits. In our case, if both firms colluded then Nintendo suffers and also make it harder for its economic growth. However, the tacit collusion is common in the United States and others countries without agreeing or any form of communication. Both Sony and Microsoft can increase its profits by cheating on the agreement, by lowering its prices and obtaining higher sales of their units at the expense of each other.

Furthermore, the dominant strategy is a cheating strategy.

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