The market for taxi services in a Midwestern town is monopolized by Firm 1. Currently, any taxiservices firm must purchase a $40,000 “medallion” from the city in order to offer its services. Apotential entrant (Firm 2) is considering entering the market. Since entry would adversely affectFirm 1’s profits, the owner of Firm 1 is planning to call her friend (the mayor) to request that thecity change the medallion fee by $F thousand. The extensive form representation of the relevantissues is summarized in the accompanying graph (all payoffs are in thousands of dollars andinclude the current medallion fee of $40,000). Notice that when F > 0, the medallion fee isincreased and profits decline; when F

a. What are firm 1’s profits if it does not call to change the fee (that is if it opts for a strategy of maintaining the status quo)? b. How much will firm 1 earn if it convinces the mayor to decrease the medallion fee by $40,000 (F = -$40) so that the medallion fee is entirely eliminated? c. How much will firm 1 earn if it convinces the mayor to increase the medallion fee by $300,000 (F = $300)? d. Determine the change in the medallion fee that maximizes firm 1’s profits. e. Do you think it will be politically feasible for the manager of firm 1 to implement the change in (d)? Explain. Answer: (a) When the firm 1 (the principal mover) doesn't require the change, firm 2 has two choices to exercise: enter and make a profit of $200 thousand or not enter and make a profit of $0. Being the profit-maximizing firm, firm 2 would decide to enter and make a profit of $200 thousand. This demonstrates under this circumstance, firm 1 would make a profit of $300 thousand. That implies, the firm 1's profit is $300 thousand in the event that it doesn't call to change the fee. (b) When the firm 1 (the principal mover) requires the change of fee by (- $40,000), firm 2 has two choices to exercise: enter and make a profit of $240 thousand or not enter and make a profit of $0. Being the profit-maximizing firm, firm 2 would decide to enter and make a profit of $240 thousand. This shows under this circumstance, the firm 1 would make a profit of $340 thousand