Question

Imagine the following hypothetical situation. Two firms, Super Chic Farm and Fortune Poultry, have become the only suppliers of fresh chicken meat in Singapore. Both firms are seeking to increase their profits and are considering entering into illicit price collusion by agreeing to charge artificially high prices. Such a practice is illegal and risks heavy fines. Analyse the interaction between the two firms using game theory. Present a payoff matrix to model the situation and analyse it for Nash equilibrium. Which is the best outcome for each firm? Which is the best outcome for society as a whole? What can be done by the firms or government to make society’s best outcome more likely?

Answer 1

If there are only two firms - Super Chic Farm and Fortune Poultry. If both try to enter into illicit price collusion to earn higher profit by artificially increasing price. This game can be represented with each player having two stretigies either follow agreement(FA) or not to follow agreement(NFA) with hypothetical numbers as-

The Nash equilibrium in the above game is NFA,NFA i.e.(5,5) as can be seen from the matrix where both values are circled.

Here the best outcome for each firm is not to follow the price agreement because it gives them higher profit than the other firm. But if both the firms follow the same stretegy both gets a lower profit which is shown as Nash equilibrium. But if both the firms follow the agreement which is obvious because they have come together so both will get the higher profit than competing with each other.

The best outcome for society as a whole is that both of them do not follow the agreement because in this situation the price will be lowest and hence the consumers will get more benefit, but the producers will also earn a considerable amount of profit as demand will increase due to less price.

In order to make the society's best outcome more likely, there must not be any price agreement between the firms and if price agreement takes place the firms must not follow it.