Question

Suppose two mining companies, Australian Mining Company (AMC) and South African Mines, Inc. (SAMI), control the only sources of a rare mineral used in making certain electronic components. The compnaies have agreed to a form a cartel to set the (profit-maximizing) price of the mineral. Each company must decide whether to abide by the agreement(i.e., not offer secret price cuts to customers) or not abide (i.e., offer secret price cuts to customers). If both companies abide by the agreement, AMC will earn an annual prodit of $30 million and SAMI will earn an annual profut of $20 million from the sales of the mineral. If AMC does not abide and SAMI abides by the agreement, then AMC earns$40 million and SAMI earns $5 million. If SAMI does not abide and AMC abides by the agreement, then AMC earns $10 million and SAMI earns $30 million. If both companies do not abide by the agreement, then AMC earns $15 million and SAMI earns $10 million.

a.) Develop a payoff matrix for this decision-making problem.

b.) In the absence of a binding and enforcable agreement, determine the dominant strategy for AMC.

c.) Determine the dominant strategy for SAMI.

d.) If the two firms can enter into a buinding and enforcable agreement, determine the strategy that each firm should choose.

Answer 1

a.

AMC(down) /SAMI(right)	abide	cheat
abide	30,20	10,30*
cheat	40*,5	15*,10*

b. In absence of binding and enforceable agreement, AMC shouldn't form a cartel or shouldn't abide by the agreement as he would by working alone will earn more than what he would be in an agreement.

c. Similarly, for SAMI, he also shouldn't enter in the cartel, or say should not abide by the agreement. Not abiding is his dominant strategy as 30 and 10 are greater than 20 and 5 respectively.

d. If the firms can enter into the agreement then they should both not abide or say should offer the secret cuts to their consumers and earn more.