Question

UPS and FedEx both struggle to deliver the surge of packages they receive during the December holiday season. According to an article in the Wall Street Journal​, in​ 2014, both firms considered charging firms such as Amazon rates that would be 10 percent higher for packages delivered during the week before Christmas. Such higher rates would likely have increased the profits of both firms. Neither UPS nor FedEx raised rates during the holiday season of​ 2014, but both firms did raise them during the 2016 holiday season. Use game theory to explain why in 2014 neither firm raised rates during the holiday​ season, but two years later both firms did. ​

Sources: Laura​ Stevens, "UPS, FedEx Got Back on Time This​ Holiday," Wall Street Journal​, December​ 29, 2014; and Paul​ Ziobro, "UPS​ Earnings: What to​ Watch," Wall Street

Journal​, January​ 30, 2017.

In 2014 neither firm raised rates during the holiday season because they were

A.

cooperating to increase their joint profits.

B.

at the equilibrium of an infinitely repeated game.

C.

colluding to maximize profits.

D.

competing in a​ prisoner's dilemma.

Both firms raised rates two years later because they were

A.

cooperating as in a repeated game.

B.

competing to attract additional customers.

C.

no longer using their dominant strategies.

D.

competing in a​ prisoner's dilemma.

Answer 1

Question 1

In 2014, both firms must be acting independently and simultaneously.

In such scenario, raising of priceby one would benefit the other and thus both firms would be in prisoner's dilemma scenario and would have settled for low price even though it leads to lower profits.

This is typical outcome of the prisoner's dilemma scenario.

So,

In 2014, neither firm raised rates during the holiday season because they were competing in a prisoner's dilemma.

Hence, the correct answer is the option (D).

Question 2

In 2016, firms had the experience of 2014. So, for them the game has changed into the repeated game scenario from the prisoner's dilemma scenario.

In the repeated game setting, cooperation leads to higher profit.

So,

Both firms raised rates two years later because they were cooperating as in a repeated game.

Hence, the correct answer is the option (A).