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Case: The package delivery industry in a country is currently dominated by one firm, UPS. UPS is trying to decide whether or not to build a new airport to reduce its shipping costs. If UPS builds an airport, they will be earn higher revenues. However, doing so may induce UPS' key competitor, FedEx, to enter into the market. The payoffs to UPS and FedEx are given in the table below:
+$200 to UPS
+$100 to FedEx
+$280 to UPS
$0 to FedEx
+$100 to UPS
-$50 to FedEx
+$250 to UPS
a. Assume that UPS first decides whether or not to build the airport, then FedEx decides whether or not to enter. In the absence of any government intervention, what is the most likely market outcome?
b. Is the outcome in part a the socially optimal outcome, where social gains are computed as the total payoffs to UPS and FedEx? If not, then come up with a tax and transfer scheme that would yield the socially optimal outcome. Be specific with your numbers.
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