Question

Suppose Firm A and Firm B exist in a duopoly facing a prisoner’s dilemma. Which of the following is not true? Select the correct answer below: Firm A will reason that it makes sense to expand output if Firm B holds down output. Neither Firm A nor Firm B has any incentive to expand output. Firm A and Firm B face parallel sets of decisions.

Answer 1

The prisoner's Dilemma can be put in place as follows

		Firm B
		Expand Output	Hold Down Output
Firm A	Expand Output	5,5	0,10
Hold Down Output	10,0	1,1

So if if both firms hold down output, then they get a payout of 1 each

If One firm holds down output while the other expands, the one holding down gets a payoff of 10 while the one expanding gets a payoff of 0.

If both expands output, both get a payoff of 5.

From the above table, we can see that Holding Down Output is a dominant strategy for both Firm A and Firm B. SO FIrm A and Firm B has no incentive to expand output.

Firm A and Firm B has the same set of decision to be made simultaneously which will give them different outcomes depending on the choice of the other. So they have parallel output.

If Firm B, holds down output, it makes sense for Firm A to Hold Down output as well instead of expanding.

So the statement which is not correct is

Firm A will reason that it makes sense to expand output if Firm B holds down output.

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