The Two-Firm Cartel Model as a Coordination Game
In game theory terms, the price-setting interaction between two firms is a coordination game because it features two Nash equilibria. The first equilibrium occurs when both firms charge a high price; this is stable because, as previously calculated, neither firm profits from unilaterally defecting. The second Nash equilibrium occurs when both firms charge a low price; in this scenario, if one firm is charging a low price, the other's best response is to also charge a low price, as setting a high price would result in zero sales. Although both outcomes are stable, the firms' owners mutually prefer the high-price equilibrium. They can achieve this more profitable outcome by forming a cartel. However, because such collusive agreements to maintain high prices are often illegal and unpopular with the public, they are typically kept secret and informal.
0
1
Tags
Social Science
Empirical Science
Science
Economy
CORE Econ
Economics
Introduction to Microeconomics Course
The Economy 2.0 Microeconomics @ CORE Econ
Ch.8 Supply and demand: Markets with many buyers and sellers - The Economy 2.0 Microeconomics @ CORE Econ
Related
Classification of Coordination Games
Conflict of Interest in a Coordination Game
The Two-Firm Cartel Model as a Coordination Game
Setup of the Windsurfing and Kitesurfing Pricing Game
Two software companies are independently deciding whether to develop their new products for 'Operating System X' or 'Operating System Y'. Both companies will earn a large profit if they develop for the same system, as this creates a larger ecosystem for third-party applications, benefiting them both. If they choose different systems, they will both earn a much smaller profit. Both companies would earn a slightly higher profit if they both chose System X over System Y, but their primary goal is to choose the same system. Which statement best analyzes the strategic situation these companies face?
The Lunch Coordination Problem
The Driver's Dilemma
For a strategic interaction to be considered a coordination game, it is essential that all players are equally satisfied with any of the potential coordinated outcomes.
Analyze the following simplified strategic scenarios. Match each scenario with the description that best characterizes the strategic interaction.
The Charging Port Standard Dilemma
Two friends, Alex and Ben, must independently choose which of two new video games, 'Starship Voyager' or 'Dungeon Quest', to buy. They will only be able to play together if they buy the same game. Their satisfaction from this decision is represented by the payoffs in the matrix below (Alex's payoff, Ben's payoff).
Ben chooses 'Starship Voyager' Ben chooses 'Dungeon Quest' Alex chooses 'Starship Voyager' (10, 10) (0, 0) Alex chooses 'Dungeon Quest' (0, 0) (5, 5) Based on an analysis of this payoff matrix, which statement best describes the strategic situation?
High-Speed Rail Investment Decision
Regional Infrastructure Investment
Two neighboring towns, A and B, are deciding on a theme for their summer festivals. They can choose either a 'Music' theme or a 'Food' theme. Their potential profits (in thousands of dollars) are shown in the matrix below, with the first number in each pair representing Town A's profit and the second representing Town B's.
Town B chooses 'Music' Town B chooses 'Food' Town A chooses 'Music' (12, 10) (5, 5) Town A chooses 'Food' (5, 5) (10, 12) Based on an analysis of this payoff matrix, which statement best describes the strategic situation?
For a strategic interaction to be considered a coordination game, it is essential that all players are equally satisfied with any of the potential coordinated outcomes.
The Two-Firm Cartel Model as a Coordination Game
Analysis of a Pricing Agreement
Two competing firms, Firm A and Firm B, secretly agree to set a high price for their identical products to maximize their joint profits. However, each firm knows that if it alone were to secretly lower its price, it would capture a significant portion of the market from the other firm, leading to an even higher individual profit. If both firms decide to lower their prices, they will both end up with lower profits than if they had both maintained the high price. From an economic perspective, what is the most probable long-term outcome of this situation?
Evaluating the Societal Impact of Cartel Instability
Consumer Benefits from Cartel Instability
In a market dominated by a few large firms that have secretly agreed to keep prices high, the individual self-interest of each firm is the primary factor that ultimately aligns their behavior with the best interests of consumers.
In a market where a group of firms has secretly agreed to coordinate their actions to keep prices high, various outcomes can occur for the firms and for consumers. Match each scenario with its most likely consequence.
Imagine a group of competing firms has successfully formed an agreement to keep prices high. Arrange the following events to illustrate the logical process that often leads to the breakdown of this agreement, resulting in a benefit for consumers.
Firm's Decision Dilemma in a Pricing Agreement
Airline Pricing Strategy Analysis
Learn After
Calculating Profit in the Two-Firm Cartel Model
Payoff Matrix for the Two-Firm Price-Setting Game (Figure 8.20)
Barriers to Entry
Two firms, Firm 1 and Firm 2, sell an identical product and must simultaneously decide whether to set a high price or a low price. Their potential profits are shown in the matrix below, with Firm 1's profit listed first in each pair.
Firm 2: High Price Firm 2: Low Price Firm 1: High Price ($100, $100) ($0, $0) Firm 1: Low Price ($0, $0) ($50, $50) Why is the outcome where both firms choose a 'High Price' considered a stable equilibrium?
Coffee Shop Coordination
Consider a market with two firms selling an identical product. Their price-setting interaction can be modeled as a game with two stable outcomes: one where both set a high price (leading to high profits for both) and one where both set a low price (leading to low profits for both). If the firms are currently in the high-price outcome, a single firm has a strong incentive to unilaterally lower its price to capture more market share and increase its individual profit.
Analyzing Firm Incentives in Duopoly Markets
Strategic Decision-Making in a Duopoly
In a market with two firms selling an identical product, their simultaneous price-setting decisions can be represented by a game. Match each strategic element or outcome of this game with its correct description.
In a market with two firms selling an identical product, their price-setting interaction can be modeled as a game with two stable outcomes. The outcome where both firms set a high price is considered a __________ because neither firm can improve its own profit by changing its price, assuming the other firm's price remains high.
Two firms, Innovate Inc. and TechCorp, are the only producers of a specialized microchip. They must decide simultaneously whether to set a high price or a low price for their product. The table below shows the daily profits for each firm based on their combined decisions. The first number in each pair is Innovate Inc.'s profit, and the second is TechCorp's profit.
TechCorp: High Price TechCorp: Low Price Innovate Inc.: High Price ($200,000, $200,000) ($0, $0) Innovate Inc.: Low Price ($0, $0) ($80,000, $80,000) Based on this information, what is the primary strategic challenge these two firms face?
Two companies, AquaPure and HydroFresh, are the only sellers of a premium water filtration system. They must decide whether to price their systems high or low. The matrix below shows their potential weekly profits, with AquaPure's profit listed first in each pair.
HydroFresh: High Price HydroFresh: Low Price AquaPure: High Price ($50,000, $50,000) ($10,000, $70,000) AquaPure: Low Price ($70,000, $10,000) ($25,000, $25,000) In this scenario, an agreement for both firms to set a high price is unstable because each has an incentive to lower its price. Which of the following changes would most effectively transform this situation into one where both firms setting a high price is a stable outcome?
Evaluating Strategic Advice in a Duopoly
Parameters of the Two-Firm Price-Setting Game