Question

TEXplor has purchased a 2-year lease on land adjacent to the land leased by

Clampett. The land leased by TEXplor lies above the same crude oil deposit. Assume each company sinks wells of the same size at the same time. If both companies sink wide wells, each will extract 2 million barrels in 6 months, but each company will receive profit of only GHC 1 million. On the other if each company sinks a narrow well, it will take a year for Clampett and TEXplor to extract their respective shares, but their profits will be GHC14 million apiece. Finally, if one company drills a wide well while the other company drills a narrow well, the first company will extract 3 million barrels and the second company will extract only 1 million barrels. In this case, the first company will earn profits of GHC 16 million and the second company will actually lose GHC 1million.

1. Illustratethisusinganormalformgame. (5marks)

2. Does either firm have a strictly dominant strategy? If yes, what is (are) these

strategies? Explain your answer.

3. What strategy will each firm adopt? Explain your answer.

4. DoesthisgamehaveaNashequilibrium?Explainyouranswer

5. Iscollusionpossibleinthisgame?Explainyouranswer.

Answer 1

1.

2. Either player in this game does not have a dominant strategy. Dominant strategy is a course of action that results in the highest payoff for a player regardless of what the other player does. The highest payoff for each player in this game is a profit of 16 million. But that is dependent upon what the other player does. Since the decision here is taken simultaneously, there is no dominant strategy.

3. The safest strategy for each firm is for both to sink narrow wells. The payoff here for both of them is a profit of 14 million.

4. This game does not have a Nash equilibrium. Nash Equilibrium is when no player can gain by a unilateral change in his strategy. But in this game, whatever strategy we choose, it can be better for one of the players.

5. Collusion is possible in this game. If both the players pre-decide to sink narrow wells, each can make sure that no losses are incurred and both earn a profit of 14 million.