Assume that in a price-fixing game, if Player A breaks the agreement in the first year, she earns $11 while Player B earns $5.However, if Player A breaks the agreement once, Player B decides to break the agreement for eternity, leaving each to receive $8 per year for the rest of their lives.If they both keep the agreement each receives $9 per year for the rest of their lives.If the discount rate is 30 percent per period:
A)Player A will prefer to break the agreement in the first year.
B)Player A will prefer to break the agreement in the second year.
C)Player A will prefer to keep the agreement throughout her life.
D)Player A will prefer to keep the agreement only for the first five years.

Question

Quizplus · Accepted Answer

To determine the best strategy for Player A, we need to compare the present value of the earnings from breaking the agreement versus keeping it. If Player A breaks the agreement in the first year, she earns $11 that year, but then earns $8 per year for the rest of her life due to Player B's retaliation. The present value of breaking the agreement can be calculated as $11 + $8/(1 - 0.3) from the second year onwards. If Player A keeps the agreement, she earns $9 per year for the rest of her life, with a present value of $9/(1 - 0.3). Comparing these values, keeping the agreement yields a higher present value, making it the preferred strategy for Player A.

Assume That in a Price-Fixing Game, If Player a Breaks