Question

Alcoa
		High price	Low price
Kaiser	High price	A $400, $500	B $175, $575
	Low price	C $525, $200	D $273, $250
		Payoffs in millions of dollars of profits per month.

Alcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose prices of their 500 foot rolls of sheet aluminum on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make.

• Is the pricing decision facing Alcoa and Kaiser a prisoners’ dilemma? Why or why not?
• What is the cooperative outcome? What is the noncooperative outcome?
• Which cell(s) represents cheating in the pricing decision? Explain.
• If Alcoa and Kaiser make their pricing decision just one time, will they choose the cooperative outcome? Why or why not?

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Now let Alcoa and Kaiser repeat their pricing decision on the first day of every month. Suppose they have been cooperating for the past few months, but now the manager at Kaiser is trying to decide whether to cheat or to continue cooperating. Kaiser’s manager believes Kaiser can get away with cheating for two months, but he also believes that Kaiser would be punished for the next two months after cheating. After punishment, Kaiser’s manager expects the two firms would return to cooperation. Kaiser’s manager ignores the time-value of money and does not discount future benefits or costs.

·         What is the monthly gain to Kaiser from cheating? What is the present value of the benefit from cheating for the two months of cheating?

·         What is the monthly cost of punishment to Kaiser? What is the pres­ent value of the cost of cheating for the two months of punishment?

·         Will Kaiser cooperate or cheat? Explain.

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Answer 1

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