Two firms are in the chocolate market. Each can choose to go for the differentia

Question

Two firms are in the chocolate market. Each can choose to go for the differentiation focused high quality market or the cost focused low quality market. Resulting profits are given by the following payoff matrix:

Firm 2

Firm 1 Low High
Low -20, -30 900, 600
High 100, 800 50, 50
a. What outcomes are Nash equilibria? (Hint: there may be more than one equilibria.)


b. If the managers of both firms are conservative and each follows a maximin (low-risk) strategy, what will be the outcome?


c. What is the cooperative outcome?



d. Which firm benefits most from the cooperative outcome? How much would that firm need to offer the other to persuade it to collude?

Explanation / Answer

First let us compare payoffs. Player 1 compares the first column vertically and player 2 compares the second columns horizontaly.

                               Firm 2

Firm 1          Low                     High
Low          -20, -30                  900, 600
High          100, 800                  50, 50

A.

As we can see there are 2 NE at (high low) and (low high)

B.

If they both follw a low risk strategy, they will end up at (low low) and will both have negative payoffs.

C.

If the cooperate, they can both price high and be at (high high) in this case the payoff is 50 for each player. Howerver, there will be a incentive to cheat the other player and price low.

D.

Firm 1 would benefit most by cooperating because in the NE he has a lower payoff (100). However, this is still higher than colluding so he would not offer player 2 any money.

Hope this helps

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