Two firms operating in the same market must choose between a collude price and a cheat price. Firm A's profit is listed before the comma, B's outcome after the comma. If each firm tries to choose a price that is best for it, regardless of the other firm's price, which of these statements is correct?

Question

Two firms operating in the same market must choose between a collude price and a cheat price. Firm A's profit is listed before the comma, B's outcome after the comma.  If each firm tries to choose a price that is best for it, regardless of the other firm's price, which of these statements is correct?

Quizplus · Accepted Answer

If both firms choose to charge a cheat price, then they will each earn $5 million in profit. If one firm chooses to charge the collude price, while the other cheats, then the cheating firm will earn $6 million while the colluding firm will earn only $4.5 million. Therefore, neither firm has an incentive to collude, and both will choose to charge the cheat price.

Two Firms Operating in the Same Market Must Choose Between