In a duopoly market, to produce a given amount of output, Firm 1 uses relatively

Question

In a duopoly market, to produce a given amount of output, Firm 1 uses relatively more capital but less labor than does Firm 2. Both firms hire labor from the same labor union, which sets the same wage for both firms. High output(4020) Firm 1 is about to bargain with the union. Whatever wage it negotiates, Firm 2 has to pay the same wage Because this industry is suffering from a downturn in demand, the union is willing to accept the current wage Firm 2 However, if Firm 1 agrees to a higher wage, its cost of production will rise by less than Firm 2's cost. The game tree shows the profits corresponding to the various actions by the firms. Firm 1's profit is A if it chooses the high wage and Firm 2 chooses the low output level. Under what condition should Firm 1 offer to pay a high wage? High wage (A,25) Low output Firm 1 Assume for simplicity the game tree is illustrated in the figure to the right High outut (70,55) Suppose that A 65 but that profits under the current wage and high output are 70 for Firm 1 and 55 for Firm 2. Which wage would Firm 1 choose? Current wag Firm 2 (60,35) Firm 1 should choose the wage Low output

Explanation / Answer

Firm chooses Current wage

Note that Firm 1 takes it decision, after observing firm 2's decision in every condition. For higher wage rate chosen by firm 1, firm 2 will select lower output as its payoff are higher (65 vs 40). For current wage rate chosen by firm 1, firm 2 will select higher output as its payoff are higher (55 vs 30)

Given these choices, firm 1 has a graeter payoff in chosing a current wage (70 vs 65)

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