2. Consider the following payoff matrix in which the numbers indicate the profit
ID: 1235177 • Letter: 2
Question
2. Consider the following payoff matrix in which the numbers indicate the profit in millions of dollars for a duopoly based either on a high-price or a low-price strategy. (2 points each)Firm A
High-price Low-price
High-price A = $500
B = $500 A = $650
B = $300
Firm B
Low-price A = $300
B = $650 A = $400
B = $400
(a) What will be the result when each firm chooses a high-price strategy?
(b) What will be the result when Firm A chooses a low-price strategy while Firm B maintains a high- price strategy?
(c) What will be the result when Firm B chooses a low-price strategy while Firm A maintains a high-price
strategy?
(d) What will be the result when each firm chooses a low-price strategy?
(e) What two conclusions can you draw about collusion?
Explanation / Answer
I am guessing this is what your table is suppose to look like:
Firm A
High-price Low-price
A = $500 A = $650
B = $500 B = $300
Firm B
A = $300 A = $400
B = $650 B = $400
a) Each firm will earn $500 million in profit for a total of $1,000 million for the two firms
b) Firm A will earn $650 million and Firm B will earn $300 million. Compared to the high-price strategy, Firm A has an incentive to cut prices because it will earn $150 million more in profit and Firm B will earn $200 million less in profit. Together, the firms will earn $950 million in profit, which is $50 million less than with a high-price strategy.
c) Firm B has an incentive to cut prices because it will earn $650 million and Firm A will earn $300 million. Compared to a high-price strategy, Firm B will earn $150 million more in profit and Firm A will earn $200 million less in profit. Together, the firms will earn $950 million in profit, which is $50 million less than with a high-price strategy.
d) Each firm will earn $400 million in profit for a total of $800 million for the two firms. This total is $200 million less than with a high-price strategy.
e) i) The two firms have a strong incentive to collude and adopt the high-price strategy because there is the potential for $200 million more in profit for the two firms than with a low-price strategy, or the potential for $50 million more for the two firms than with a mixed-price strategy.
ii) There is also a strong incentive for each firm to cheat on the agreement and adopt a low-price strategy when the other firm maintains a high-price strategy because this situation will produce $150 million more in profit for the cheating firm compared to honoring a collusive agreement for a high-price strategy.
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