2. Two firms, say Kmart and Target, have to make a pricing following pricing mat
ID: 1116609 • Letter: 2
Question
2. Two firms, say Kmart and Target, have to make a pricing following pricing matrix: Price farget Pric S600 $400 Kma S600 KS10K K S5K rt TS10k TS15k $400 KS15K K$7.5K TS5K TS7.5k (i) Does any of the firms have a dominant or nondominant strategy? Why? (ii) What is the Nash Equilibrium? Why? Is there a prospect for a collusive pricing outcome? Why? In the light of US antitrust laws, briefly evaluate the impediments to such a pricing strategy. 3. Bonus: You may use the kinked demand model and its limitations to evaluate the arguments for price stability in the oligopolistic structure. [NB: QT Review sessionExplanation / Answer
There is a dominant strategy for both the players. A dominant strategy is the best possible action taken by one player irrespective of the action taken by the other. Kmart observes that if the rival Target selects a price of $600 then it is better for Kmart to select $400 and earn a higher profit of $15. Similarly the Rival chooses $400 Kmart will be again choosing $400 as a price because this will earn it a better pay off of $7.5. the same is the case with the rival Target. NZ both have a dominant strategy of choosing $400 as there price. The Nash equilibrium is set of strategies chosen by the rival as their best possible action given the reaction of the Rivals. The Nash equilibrium is 400 400. This implies that the bottom right cell in the matrix represents the Nash equilibrium where both the firms are charging a price of $400
There is a chance of collusive pricing because the current Nash equilibrium has a lower pair of $7.5. If they co-ordinate and collectively choose to price $600 the profit will increased to $10. In the light of antitrust laws this will be regarded as an illicit practice because this will increase the price for consumers. Antitrust laws do not allow any collusive agreement between firms to charge higher prices.
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