The payoff matrix below presents the profits for Firm A and for Firm B under the

Question

The payoff matrix below presents the profits for Firm A and for Firm B under the various pricing Strategies. Suppose both firms have agreed to maximize their combined profits by colluding on their pricing strategies, woe the information in this payoff matrix to answer the following two questions. Compare the profits of Firm A when both firms respect the collusive agreement to the profits of Firm A when Firm A secretly cheats on the agreement. How much additional profit would Firm A earn by secretly cheating on the agreement to collude? (Round your answer to the nearest whole number.) Compare the profits of Firm A when both firms respect the collusive agreement to the profits of Firm A when both firms cheat on the agreement. By how much would the profit of Firm A fall if both firms cheat on the agreement to collude? (Round your answer to the nearest whole number.)

Explanation / Answer

The given pay-off matrix shows that if both firm collude on their pricing strategies to maximize their combined profits then both firms will adopt the high price strategy as this strategy results in maximum profits.

Q1. When both firms respect the collusive aggrement and remain committed to high price strategy, each get 87 as profit.

So, Firm A earns 87 as profit when both firms respect the collusive aggrement.

Now, Firm A cheats. This implies that Firm A instead of remaining committed to high price strategy adopts the low-price srategy while Firm B is still adopting the high price strategy. In such case, cheating results in Firm A's profit being increased to 105.

Calculate additional profit earned by Firm A by cheating -

Additional profit earned = Profit with cheating - Profit without cheating = 105 - 87 = 18

The additional profit earned by Firm A would be $18.

Q2. When both firms respect the collusive aggrement and remain committed to high price strategy, each get 87 as profit.

So, Firm A earns 87 as profit when both firms respect the collusive aggrement.

Now, both firms cheat and adopts the strategy of low prices. If both firms cheat and adopts the strategy of low price then both get pay-off of 75 each.

Thus, firm A will get profit of 75 if both firm cheat.

Calculate fall in profit of firm A when both firms' cheat -

Fall in profit = Profit without cheating - profit when both cheat

                 = 87 - 75

                 = 12

The profit of Firm A will fall by $12.

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