Trade Policies using Game Theory

Example - Monopolist and New Entrant in the World Market
In this example, there is a monopolist in the market facing a potential new entrant. The monopolist can choose to fight (F) or acquiesce (A). The new entrant can choose to enter (E) or not (N). The payoffs are as follows: If the new entrant doesn't enter the market, the monopolist will retain its position. [1] If the new entrant enters and the monopolist fights, they will both lose market share. [2] If the new entrant enters and the monopolist acquiesces, they both gain, but the monopolist's share is reduced. [3] We find that there is no dominant strategy for either player, but there are two Nash equilibria (F, N) and (A, E). [4]
Backward Induction
In this game, it is the new entrant who makes the first move - to enter or not. If it chooses E, [1] the monopolist has two choices F and A, [2] and will choose A for a payoff of 2. [3] On the other hand, if the new entrant chooses N, [4] the monopolist again has two choices, both of which have the same payoff. [5] Now, if the new entrant compares its payoffs for each of the monopolist's choices, [6] it finds that its best payoff is 2, by entering the market and the monopolist acquiescing. [7]
If the government of the potential entrant considers the sector is important, the government can provide an incentive by subsidising the entrant and guaranteeing positive profits when it enters the market.

Example - Monopolist and New Entrant in the World Market