1. Two firms produce a similar product such as computer hard drives. Each can ei
ID: 1219022 • Letter: 1
Question
1. Two firms produce a similar product such as computer hard drives. Each can either charge a high or low price for their good. If they both charge a high price, they will make a high profit margin. If one charges a high price and the other charges a low price, the high price firm will be driven out of the market. If both charge a low price, they will make a low profit margin. Assuming no collusion takes place, what is the most likely scenario in this market?
what is the most likely scenario if collusion can take place?
Why do small markets with differentiated products (such as the cola market—Pepsi, Coke, etc.) not lead to price wars?
Explanation / Answer
Both the firms makes the similar product.
If both charges high, high potential of profits for the both.
If one charges high and other charges low, there is high potential profit for the firm which charges lower.
Now both the firms have to make decision in isolation, this is the same case, as that in case of prisonner's dillema.
Both firms finds that if they charges low they could have higher potential than other, which ultimately lead to the situation where both the firms are charging low prices.
Most likely scenerio when collusion takes place, now the firms act as a single firm, they know that it is good to charge a high price to get the maximum profits, and the most likely scenerio is that there is a high market price prevailing in the market.
This is the reason why small firms makes differentiated products rather than fighting with price, because they know that if they try to fight on the basis of price, the ultimate result would be lower market prices they receive for both of the firms.
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