Question

UPS and FedEx both struggle to deliver the surge of packages they receive during the December holiday season. According to an article in the Wall Street Journal , in 2014, both firms considered charging firms such as Amazon rates that would be 10 percent higher for packages delivered during the week before Christmas. Such higher rates would likely have increased the profits of both firms. Neither UPS nor FedEx raised rates during the holiday season of 2014, but both firms did raise them during the 2016 holiday season. Use game theory to explain why in 2014 neither firm raised rates during the holiday season, but two years later both firms did. Sources: Laura Stevens, "UPS, FedEx Got Back on Time This Holiday," Wall Street Journal , December 29, 2014; and Paul Ziobro, "UPS Earnings: What to Watch," Wall Street Journal , January 30, 2017. In 2014

neither firm raised rates during the holiday season because they were

A. competing in a prisoner's dilemma.

B. colluding to maximize profits

. C. cooperating to increase their joint profits.

D. at the equilibrium of an infinitely repeated game.

Both firms raised rates two years later because they were

A. competing in a prisoner's dilemma.

B. no longer using their dominant strategies.

C. competing to attract additional customers.

D. cooperating as in a repeated game.

Answer 1

Question 1

In 2014, both firms must be acting independently and simultaneously.

in such scenario, raising of price by one would benefit the other and thus both firms have found themselves in prisoner's dilemma scenario where cooperation in terms of charging high price would have increased their profits but lack of cooperation between them has resulted in each firm charging a lower price and thus earning the lower profit.

This is the typical outcome of the prisoner's dilemma game.

So,

In 2014, neither firm raised rates during the holiday season because they were competing in a prisoner's dilemma.

Hence, the correct answer is the option (A).

Question 2

In 2016, firms through their previous experience have understood that cooperating and charging higher rates would benefit both of them and would lead to higher profits for each of them.

Thus, now their interaction has changed into a repeated game scenario.

In the repeated game setting, cooperation leads to higher profit.

So,

Both firms raised rates two years later because they were cooperating as in a repeated game.

Hence, the correct answer is the option (D).