In a duopoly with a collusive agreement to restrict output and raise the price,

Question

In a duopoly with a collusive agreement to restrict output and raise the price, a firm's best strategy is to ______ if the other firm complies, and to ______ if the other firm cheats.

A. comply; comply

B. comply; cheat

C. cheat; cheat

D. cheat; comply

A collusive agreement creates a game like the prisoners' dilemma because _______.

A. the outcome is better than if both firms held to the agreement

B. the outcome is worse than if both firms held to the agreement

C. collusion is illegal and the players will end up in jail if caught

D. collusion is illegal and the players will end up with the maximum jail time

When some firms exit a market in which firms incur economic losses, the market supply curve shifts ______, the market price ______, and each remaining firm's economic loss ______.

A. leftward; falls; decreases

B. rightward; falls; decreases

C.rightward; rises; increases

D. leftward; rises; decreases

Explanation / Answer

Duopoly is a market with two firms. Each has a considerable impact on the market. They can fix their strategies after considering reaction of rivals. When they operate indepedetly, a contiuous price cut is observed. As a result both firm will suffer. In order to overcome this situation, very often they form an agreement and act accordingly. They restrict quantity and set a high price.

Often there is a tendency to violate agreement. In that case if one firm cheats other will also cheat, so that both can come back towards agreement.

Answer: In a duopoly with collusive agreement to restrict output and raise price, a firms best strategy is to comply if other firm complies and to cheat if other firm cheats.

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Prisoners Dilema is a strategy of game theory. In prisoners Dilema, the solution or Nash equilibrium does not benefit both parties. So they deviate and adopts a strategy which will give better reult to both of them. If one person cheats, then other will also cheat. Result will be a loss to both.

So collusive agreement is like Prisoners Dilema. because outcome is better if both firm held the agreement.

So option A is correct.

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Economic loss is a situation when firm is not able to earn normal profit. In this situation, some firms will left the market if variable cost is not recovered. As a result supply will decrease. Supply curve will shift to the left. Due to less supply market price will rise and economic loss of each existing firm will decrease.

Thus option D is correct.

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