Question

Consider a cartel, the Organization of the Rice Exporting Companies (OREC), which is a group of rice-exporting countries. Although OREC has eight members, let’s keep it simple and assume there are only two: China and Vietnam. The figure below shows the payoff matrix for the game.

Each country must choose how much rice to produce, either low output or high output. Note that this payoff matrix is not symmetric. At any outcome, China makes more money than Vietnam because China is the dominant member of OREC.

Part 1   (0.2 point)

If the countries colluded,

Part 2   (0.2 point)

China’s dominant strategy is to produce a

Part 3   (0.2 point)

Vietnam’s dominant strategy is to produce a

Part 4   (0.2 point)

The Nash equilibrium for these two countries is

Part 5   (0.2 point)

Suppose that the countries try to cooperate over a longer time. Although this strategy allows the countries to develop strategies like tit-for-tat, which may sustain collusion, cartel members may still try to cheat. Which of the two countries is more likely to cheat on a cartel agreement?

Answer 1

1. When both firms collude both will end up with choosing Low output because it increases payoff of both firms.

2. Dominant strategy is a strategy for a player i.e. best response to all strategy profile of other player.

China's dominant strategy is to choose high output because it gives China higher payoff as compared to when it produced low output.

3. Vietnam has the dominant strategy of producing high output because it gives country greater payoff as compared to when it produces low output.

4. Nash equilibrium is a strategy profile such that for each player given strategy, it is best response. Nash equilibrium is a set of strategies such that each player is doing their best given the strategy of other player.

If China chooses to produce low output then best response of Vietnam is to produce high output because higher output gives Vietnam greater payoff.

If Vietnam produces higher output then best response of China is to produce high output.

So, (Low output; High output) is not the nash equilibrium.

If China chooses to produce High output then best response of Vietnam is to produce high output because higher output gives Vietnam greater payoff.

If Vietnam produces higher output then best response of China is to produce high output.

So, (High output; High output) is the nash equilibrium.

5. If both firms collude and produce low output then firms try to cheat and produce high output.