Consider the following information for a simultaneous move game: If you charge a

Question

Consider the following information for a simultaneous move game: If you charge a low price (LP) and your rival charges a LP, you each will earn $5 million in profits. If both charge a high price (HP), each will each earn $10 million in profits. However, if one charge a LP and the other does not, the firm that charges a LP will earn $15 million and the other firm will earn $1 million.

If both firms plan to be in business for oneyear, the Nash Equilibrium will be

a) For each firm charge LP

b) For neither firm to charge LP

c) For one firm to charge LP and the other HP

d) None of the above.

If both firms plan to be in business for 5 years, then the Nash Equilibrium will be

a) For each firm charge a LP every year

b) For neither firm to charge a LP in early years, but to charge a HP in later years.

c) For each firm to charge a HP every year

d) For neither firm to charge a HP in early years, but to charge a LP in later years.

If the businesses last forever, then the Nash Equilibrium is

a) for one firm to charge a HP forever

b) for your firm charge a LP when the other firm does

c) for each firm to charge HP until the rival does, and then to charge a LP forever.

d) for each firm to charge LP until the rival does, and then to charge a HP forever

Explanation / Answer

a) For both firms, charging a low price is a dominant strategy even though it is an Pareto inferior outcome. Hence it is Nash equilibrium when both charges a lower price. Option A

b) There seems to be no change in the results when game is repeated for five times. Here also option A is correct

c) When it is repeated in definitely, firms realize that a better option is to charge a higher price so they coordinate and settle for a higher price. Then the Nash equilibrium is when both charges a high price. Cheating or deviation will result in low price forever. Option C

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