Question

It is illegal for any two firms that sell similar products to engage in price fixing agreements. Violating the anti-trust laws can bring both civil and criminal prosecutions. Nevertheless, price fixing does take place. Examples would be found at the service plazas along the NY State Thruway and the NJ Turnpike. Each location has a small number of fast food restaurants. Each fast food restaurant belongs to a different firm, which should create competition, yet at service plazas all have uncommonly high prices.

A. Draw a prisoner’s dilemma type of game (2x2) to show the pricing choices and strategies of two competing fast food restaurants, located at one service plaza. Payoffs are daily profits. Create sensible numbers. Write a brief explanation for the different numbers that you have created.

B. Identify John Nash’s equilibrium, as well as the optimal outcome for the two fast food outlets. Also find and label any strictly dominant strategies.

C. Actual long run pricing results at the service plaza may be contrary to the results predicted by the 2x2 diagram from part A. Explain why actual results may differ in the long run. Why is competition between different firms unable to bring lower prices to the consumer at the service plaza?

Answer 1

Given data:

· It is illegal for any two firms that sell similar products to engage in price fixing agreements.

· Each fast food restaurant belongs to a different firm, which should create competition, yet at service plazas all have uncommonly high prices.

AA	DD
AB	AC

· Assume two vendors are selling pizzas they are having the below choices as per prisoners game theory.

Pizza breakeven price - $10

ü A – Selling pizzas as per agreement

ü B – Defecting agreement one sells at higher price

ü C – Defecting Agreement one sells at lower price

ü D – No Agreement and open market prices at each outlets

ü AA – Selling 100 pizzas at $15 profiting $500 each

ü DD – Both are selling 100 pizzas each at $10 profiting $0 each

ü AB – One sells 50 pizzas at $17 profiting $350 and another one earns $750 by selling 150 pizzas at $15

ü AC – One sells 150 pizzas at $12 profiting $300 and another earns $250 by selling 50 pizzas at $15

ASSUMPTIONS:

Ø AA – If both are selling at agreed prices both of them gains $500 each

Ø DD – If there is no agreement then both gains $0, because of fear they may lose business if other one decreases prices. So the price comes to equilibrium and stays.

Ø AB – If one sells at higher price other to make extra profits makes little higher profit of $560 by losing some quantity to another one who makes $600 by selling 120 pizzas.

Ø AC – If one sells at lower price ($12) to gain market share makes $300 and another earns $250 by losing market share.

CONDITION:

Ø The vendors have to share the customers themselves, that is the reason even the prices reduced by one vendor doesn’t attracted new customers rather only pulls customers of another vendor.

Ø There is no elasticity of demand in relation to price is zero, because no one goes to highways just to buy only pizzas.

SCENARIO:

1. In the above cases AB, AC – Despite who ever breaches agreement possibility of loss may occur to either.

2. If both honours the agreement, due to zero elasticity of demand in relation with prices, there is no loss in number of customers and both gains.

3. If they don’t have agreement they will reduce prices till it reaches breakeven and no one gains.

1. There is no price competition if the vendors couldn’t attract new buyers.