[2] Suppose firms 1 and 2 must simultaneously choose between charging a low pric
ID: 1212359 • Letter: #
Question
[2] Suppose firms 1 and 2 must simultaneously choose between charging a low price or a high price for their individual products. The payoff matrix is illustrated below:
Firm 2
Low P
High P
Firm 1
Low P
6, 6
14, 5
High P
5, 14
12, 12
Note: Firm 1’s payoffs are listed first, while firm 2’s payoffs are listed second.
A. Imagine these two firms are contemplating a price fixing scheme, whereby they agree to each charge a high price. If they play this game once, is such an agreement sustainable? Explain.
B. If they play this game 5 times, with each firm adopting a tit-for-tat strategy, can we sustain cooperation? Explain.
C. If they play this game an infinite numbers of times, with each firm adopting a trigger strategy, under what specific conditions can the price fixing scheme be sustained forever? Explain.
Firm 2
Low P
High P
Firm 1
Low P
6, 6
14, 5
High P
5, 14
12, 12
Explanation / Answer
A. No, if this game is played once then, each firm wants to increase its profit to 14 irrespective of earning 12. So, they will not cooperate and try to charge lower price so that they can get 14. As a result, both will get payoff of (6,6) because both firms react in same way when game is played once.
B. No, there will be no cooperation if the game is played for finite number of times because any firm can try to adopt low price at any time to earn more benefit. If both firm starts by charging higher price then, if any firm retaliate and charge low price then at that time other firm will suffers loss and it will also lower its price. This reduces their future price to low level.
C. In infinitely repeated game, outcome leads to cooperative behaviour because both firms know that if they retaliate once then, other firm will also apply tit-for-tat strategy and charge low price and will reduce their future earning. So, both firms cooperate when game is played for an infinite number of times.
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