The Cartel Game

Two firms are trying to decide how much output to produce.If they collude and act like a cartel, each will cut back on production and keep prices high.If they cheat on the cartel quota and expand production, both firms will overproduce; prices will be low, and profits will be low.If one cheats while the other produces at quota level, the one that cheats gains the benefits of higher prices than if both cheated, and the one that produced the quota gets hurt because prices are lower than they would be if both firms restricted output.Profits for firms A and B are given for the production levels low production and high production in the table below.

B

Low High

Production Production

10

10 8

12

12

8 9

9

1.

a. If firm B chooses low production then firm A should choose _______________________ because the profit from low production _____________________(qty) is ________________ than the profit from high production ____________________(qty.

b. If firm B chooses high production then firm A should choose ______________________ because the profit from low production _________________(qty) is ________________ than the profit from high production ____________________(qty.

c. Is one strategy always best for firm A?Which strategy?Explain.

We say the strategy_____________________dominates the strategy_____________________.

2.

a. If firm A chooses low production then firm B should choose _______________________ because the profit from low production ___________________(qty) is ______________ than the profit from high production _____________________(qty).

b. If firm A chooses high production then firm B should choose ______________________ because the profit from low production ___________________(qty) is ______________ than the profit from high production _____________________(qty).

c. Is one strategy always best for firm B?Which strategy?Explain.

We say the strategy_____________________dominates the strategy_____________________.

3. What is the Nash equilibrium outcome of this game?Explain why this is the equilibrium.