Question

Please use paper to answer, thanks.

Need diagram !!!!!!!!!

Q1: Suppose two small-town video stores, store A and store B, compete. The two stores collude and agree to share the market equally. If neither store cheats on the agreement, each store will make $2,500 a day in economic profits. If only one store cheats, the cheater will increase its economic profits to $4,000 and the store that abides by the agreement will incur an economic loss of $1,000. If both firms cheat, they both will earn zero economic profits. Neither store has any way of policing the actions of the other.

(a) What is the payoff matrix if the game is played just once?

(b) What is the equilibrium if the game is played only once? Explain.

(c) What do you think will happen if the game is played many times? Why?

(d) What do you think will happen if a third firm comes into the market? Will it be harder or easier to achieve cooperation among the three firms? Why?

Answer 1

Answers:

b) Nash equilibrium = (cheat, cheat)

c) If game played many times then both firm cooperate.

d) when third firm comes cooperation becomes difficult as competition increases and it is difficult to make a agreement which satisfy all three firms.

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Explanations:

a)   Store B

Cooperate Cheat

Cooperate (2500,2500) (-1000,4000)

Store A

Cheat (4000, -1000) (0, 0)

.

b) When game played only once each firm choose to cheat because each firm have greater incentive to cheat when one store cooperate, so they both end up cheating and get payoff of 0.

c) When game played many times, then if any store cheats the other firm will not cooperate and cheated firm earn 4000 profit only once than earns 0 thereafter which is less profitable when they both cooperate.

d) When third firm comes the competition in the market increases which makes the cooperation difficult.