Assume there are two firms, A and B. Following a decrease in variable cost that
ID: 1253521 • Letter: A
Question
Assume there are two firms, A and B. Following a decrease in variable cost that affects both firms, each firm must decide to lower price or to maintain price. If firm A maintains price and B maintains its price, each firm will have profits of $120 during the time period. If Firm A lowers its price and B lowers its price, each firm will have profits of $100. If Firm A lowers its price and B maintains its price, then A has profits of 110 and B profits of 80. If Firm B lowers its price and A maintains its price, then B has profits of $150 and A profits of $80.What stratgey will each firm follow, indicting whether each firm has a dominant stratgey or not
Explanation / Answer
This is a standard game theory question; each firm will lower costs, because that way they incur minimum losses on their profits. The theory is simple; if both firms maintain price, they both benefit together, but if one firm decides to lower prices then it will benefit more than the other firm; neither firm can guarantee that the other will not lower prices, so in the end, to protect their own interests and minimize losses, both firms will lower prices. Hope this helps!