Suppose that Firm A deviates from a trigger strategy to support a high price.What is the present value of A's payoff from cheating?
A)5.
B)20.
C)25.
D)35.

Question

Quizplus · Accepted Answer

The present value of A's payoff from cheating is equal to the difference between the discounted profits from cheating and the discounted profits from playing the trigger strategy. The discounted profits from cheating can be calculated as follows:

PV(A's profits from cheating) = 0.6(40) + 0.4(20) / (1 + 0.05) = 38.095

The discounted profits from playing the trigger strategy can be calculated as:

PV(A's profits from trigger strategy) = 0.6(30) + 0.4(10) / (1 + 0.05) = 26.19

Therefore, the present value of A's payoff from cheating is:

PV(A's cheating payoff) = 38.095 - 26.19 = 11.905

Since this payoff is greater than the cost of cheating (which is 5), A will choose to deviate from the trigger strategy and support a high price. The correct answer is C, 25.

Suppose That Firm a Deviates from a Trigger Strategy to Support