Question

There are two firms in the residential paint industry, Cool Shades (C) and Warm Hues (W). They collude to share the market equally. They jointly set a monopoly price and split the quantity demanded at that price. Here are their options: i. They continue to collude (no cheating) and make $12 million each in profits. ii. One firm cheats and the other does not. The firm that cheats makes a profit of $14 million, whereas the firm that does not makes a profit of $9 million. iii. They both cheat and each firm makes a profit of $7 million.

a. Construct a payoff matrix for these two firms.

b. How does this situation relate to the prisoner's dilemma?

c. If each firm acted noncooperatively, how much profit would each make?

d. Are the firms better off colluding (with no cheating) or competing? Explain.

Answer 1

C/W	Collude	cheat
Collude	(12,12)	(9,14)
Cheat	(14,9)	(7,7)

A) Payoff matrix is above

The first value in each cell, shows profit of firm C

The second value corresponds to profit of firm W

.

B) this is not a prisoners dilemma game exactly, but only the common thing is that , if both Firms Collude , then both are certain to have a higher profit level

.

C) non Cooperatively , then two NE exists

Each firm can either have π = 14 or 9

	Collude	cheat
Collude	(12,12)	(9*,14•)
Cheat	(14*,9•)	(7,7)

D) yes, if both Firms Collude & Cooperate , then it's sure both earn profit of 12