Alcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose pr
ID: 1162649 • Letter: A
Question
Alcoa and Kaiser, duopolists in the market for primary aluminum ingot, choose prices of their 500 foot rolls of sheet aluminum on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make.
Alcoa High price Low price Kaiser High price A $400, $500 B $175, $575 Low price C $525, $200 D $273, $250 Payoffs in millions of dollars of profits per month.
Is the pricing decision facing Alcoa and Kaiser a prisoners’ dilemma?
Why or why not? What is the cooperative outcome?
What is the noncooperative outcome?
Which cell(s) represents cheating in the pricing decision? Explain.
If Alcoa and Kaiser make their pricing decision just one time, will they choose the cooperative outcome? Why or why not?
Explanation / Answer
Yes, pricing decision facing Alcoa and Kaiser is prisoners' dilemma because in the above case firms fail to cooperate with each other, even when cooperation would bring about a better collective outcome.
The prisoner’s dilemma is a canonical example of a game analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interest to do so.
In the prisoner’s dilemma scenario, cooperation is difficult to maintain in an oligopoly because cooperation is not in the best interest of the individual players. However, the collective outcome would be improved if firms cooperated, and are thus able to maintain low production, high prices, and monopoly profits.
Colluding to charge the monopoly price and supplying one half of the market each is the best that the firms could do in this scenario. However, not colluding and charging the marginal cost, which is the non-cooperative outcome, is the only Nash equilibrium of this model.
A $4000,$500 is the noncooperative outcome which is only Nash equilibrium here.
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