Question

The widget market is controlled by two firms: Acme Widget Company and Widgetway Manufacturing. The structure of the market makes secret price cutting impossible. Each firm announces a price at the beginning of the time period and sells widgets at the price for the duration of the period. There is very little brand loyalty among widget buyers so that each firm's demand is highly elastic. Each firm's prices are thus very sensitive to inter-firm price differentials. The two firms must choose between a high and low price strategy for the coming period. Profits (measured in thousands of dollars) for the two firms under each price strategy are given in the payoff matrix below.

		Acme
		low price	high price
Widgetway	low price	60,60	250,-20
	high price	-20, 250	130, 130

(a) Does either firm have a dominant strategy? What is the Nash Equilibrium of this game, if any? Is the equilibrium Pareto efficient?

(b) If the two firms are in this game for the long haul, would a tit-for-tat strategy be a reasonable choice? Explain this strategy and the resultant outcome or payoffs for the firms.

(c) In actual practice, firms often employ price-matching guarantee to resolve the Prisoner’s Dilemma of price competition. Explain what is a price-matching guarantee and discuss how it is similar to or different from the tit-for-tat strategy of part (b).

Answer 1