Suppose there are only two firms in an industry. If they each set a high price, they each earn $5000. If they each set a low price, they each earn $2500. If one firm sets a low price while the other sets a high price, the low- price firm earns $7000 while the high- price firm earns $1000. Does a prisoners' dilemma exist?

Question

Quizplus · Accepted Answer

A prisoners' dilemma occurs when each player has an incentive to choose a certain strategy, even though the combined payoff would be greater if both players chose a different strategy. In this case, the dominant strategy for both firms is to set a high price, as it results in a higher payoff than setting a low price regardless of what the other firm chooses. However, if both firms choose this dominant strategy, they only earn a combined total of $10,000. If one firm deviates and sets a low price, they can earn more for themselves ($7,000) but cause the other firm to earn less ($1,000), resulting in a combined total of $8,000. This is the Nash equilibrium, as neither firm can unilaterally improve their outcome by changing their strategy. However, this equilibrium does not maximize the joint payoff, as the firms would earn more if they both chose to set a low price and earned a combined total of $5,000. Therefore, a prisoners' dilemma exists in this scenario, and the best choice is D.

Suppose There Are Only Two Firms in an Industry