Question

Two firms choose the prices of their products on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they can make

		Firm B
		Low Price	High Price
Firm A	Low Price	$400, $600	$100, $700
	High Price	$600, $300	$150, $400

1. Is the Pricing decision facing the 2 firms a prisoner’s dilemma situation? Why or why not?
2. What is the outcome of the game if the firms do not cooperate in making the decision to choose their prices? Why?
3. What is the outcome of the game if the firms do cooperate in making the decision to choose their prices? Why?

Answer 1

Q1. Yes. The pricing decision is a Prisoners'dilemma situation.

Here, each firm has a strictly dominant strategy to charge high price. That is no matter what the other firm does, each firm gets a higher Payoff by pricing high rather than pricing low.

In this case, the dominant strategy outcome gets firm 1 $150 and firm 2 $400. But this is not Pareto efficient outcome because each of the both firms can get a higher payoff by pricing low.

In this game, each player has a strictly dominant strategy that will lead to an outcome which is Pareto inefficient. So, this is a Prisoners'dilemma situation.

Q2. {High price, High price}

​​​​​​As we saw in the earlier part, if both firms choose to maximize their payoff without cooperation, they will end up with outcome where each of them charge high price. Because each firm gets higher Payoff by pricing high no matter what other firm does.

Q3. {Low price, Low price}

​​​​​​We have seen in the Q1 that each firm can get a higher Payoff by charging low. If both cooperate, that is if each firm promise to charge low price, then each firm can get a higher payoff than by not cooperating. This outcome is Pareto efficient too. Here, firm 1 gets $400 and firm 2 gets $600.