Question

THERE IS NO MORE INFO, ONLY THIS, THANK YOU

2. 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

A prisoner’s dilemma describes a situation where, according to game theory, two players acting strategically will ultimately result in a suboptimal choice for both. When it comes to the competition between two fast-food restaurants, understanding the structure of certain decisions as prisoner’s dilemmas can result in more favorable outcomes because it will allow balancing both competition and cooperation for mutual benefit.

Prisoner’s Dilemma Basics

The prisoner’s dilemma scenario works as follows: Two suspects have been apprehended for a crime and are now in separate rooms in a police station, with no means of communicating with each other. The prosecutor has separately told them the following:

• If you confess and agree to testify against the other suspect, who does not confess, the charges against you will be dropped and you will go scot-free.
• If you do not confess but the other suspect does, you will be convicted and the prosecution will seek the maximum sentence of three years.
• If both of you confess, you will both be sentenced to two years in prison.
• If neither of you confesses, you will both be charged with misdemeanors and will be sentenced to one year in prison.

Now, evaluating best course of action

Let’s begin by constructing a payoff matrix where two fast food restaurants located at one plaza compete with each other. Suppose one fast food restaurant is thinking of cutting the price then the other will have no choice but to follow suit for its fast-food to retain its market share. This may result in a significant drop in profits for both fast-food restaurants.

A price drop by either fast- food restaurant may thus be construed as defecting since it breaks an implicit agreement to keep prices high and maximize profits. Thus, if fast-food restaurant 1 drops its price but fast food restaurant 2 continues to keep prices high, the former is defecting, while the latter is cooperating (by sticking to the implicit agreement). In this scenario, fast food restaurant 1 win market share and earn incremental profits by selling more food.

Payoff Matrix

Let’s assume that the incremental profits that accrue to fast food restaurant 1 & 2 are as follows:

The payoff matrix looks like this: (the numbers represent incremental dollar profits in hundreds of millions):

	Fast food restaurant 1
Fast food restaurant 2		Cooperate	Defect
Cooperate	$100, $100	0,$75
Defect	$75, 0	$85, $85

Now,

i) If both the fast-food restaurants keep prices high, profits for each restaurants increase by $100 million ( because of normal growth in demand).

ii) If one drops prices (i.e. defects) but the other does not (cooperates), profits increase by $75 million for the former because of greater market share and are unchanged for the latter.

iii) If both the restaurants reduce prices, the increase in fast-food consumption offsets the lower price, and profits for each restaurants increase by $85 million.

Price Fixing

Price fixing is an agreement (written, verbal, or inferred from conduct) among competitors that raises, lowers, or stabilizes prices or competitive terms. Generally, the antitrust laws require that each company establish prices and other terms on its own, without agreeing with a competitor. When consumers make choices about what products and services to buy, they expect that the price has been determined freely on the basis of supply and demand, not by an agreement among competitors. When competitors agree to restrict competition, the result is often higher prices. Accordingly, price fixing is a major concern of government antitrust enforcement.

A plain agreement among competitors to fix prices is almost always illegal, whether prices are fixed at a minimum, maximum, or within some range. Illegal price fixing occurs whenever two or more competitors agree to take actions that have the effect of raising, lowering or stabilizing the price of any product or service without any legitimate justification. Price-fixing schemes are often worked out in secret and can be hard to uncover, but an agreement can be discovered from "circumstantial" evidence. For example, if direct competitors have a pattern of unexplained identical contract terms or price behavior together with other factors (such as the lack of legitimate business explanation), unlawful price fixing may be the reason. Invitations to coordinate prices also can raise concerns, as when one competitor announces publicly that it is willing to end a price war if its rival is willing to do the same, and the terms are so specific that competitors may view this as an offer to set prices jointly.

Not all price similarities, or price changes that occur at the same time, are the result of price fixing. On the contrary, they often result from normal market conditions. For example, prices of commodities such as wheat are often identical because the products are virtually identical, and the prices that farmers charge all rise and fall together without any agreement among them. If a drought causes the supply of wheat to decline, the price to all affected farmers will increase. An increase in consumer demand can also cause uniformly high prices for a product in limited supply.

Price fixing relates not only to prices, but also to other terms that affect prices to consumers, such as shipping fees, warranties, discount programs, or financing rates. Antitrust scrutiny may occur when competitors discuss the following topics:

• Present or future prices
• Pricing policies
• Promotions
• Bids
• Costs
• Capacity
• Terms or conditions of sale, including credit terms
• Discounts
• Identity of customers
• Allocation of customers or sales areas
• Production quotas
• R&D plans

A defendant is allowed to argue that there was no agreement, but if the government or a private party proves a plain price-fixing agreement, there is no defense to it. Defendants may not justify their behavior by arguing that the prices were reasonable to consumers, were necessary to avoid cut-throat competition, or stimulated competition.

Example: A group of competing optometrists agreed not to participate in a vision care network unless the network raised reimbursement rates for patients covered by its plan. The optometrists refused to treat patients covered by the network plan, and, eventually, the company raised reimbursement rates. The FTC said that the optometrists' agreement was illegal price fixing, and that its leaders had organized an effort to make sure other optometrists knew about and complied with the agreement.

An agreement to restrict production, sales, or output is just as illegal as direct price fixing, because reducing the supply of a product or service drives up its price. For example, the FTC challenged an agreement among competing oil importers to restrict the supply of lubricants by refusing to import or sell those products in Puerto Rico. The competitors were seeking to pressure the legislature to repeal an environmental deposit fee on lubricants, and warned of lubricant shortages and higher prices. The FTC alleged that the conspiracy was an unlawful horizontal agreement to restrict output that was inherently likely to harm competition and that had no countervailing efficiencies that would benefit consumers.

A: A uniform, simultaneous price change could be the result of price fixing, but it could also be the result of independent business responses to the same market conditions. For example, if conditions in the international oil market cause an increase in the price of crude oil, this could lead to an increase in the wholesale price of gasoline. Local gasoline stations may respond to higher wholesale gasoline prices by increasing their prices to cover these higher costs. Other market forces, such as publicly posting current prices (as is common with most gasoline stations), encourages suppliers to adjust their own prices quickly in order not to lose sales. If there is evidence that the gasoline station operators talked to each other about increasing prices and agreed on a common pricing plan, however, that may be an antitrust violation.

A: No. Matching competitors' pricing may be good business, and occurs often in highly competitive markets. Each company is free to set its own prices, and it may charge the same price as its competitors as long as the decision was not based on any agreement or coordination with a competitor.