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Payoff Matrix and Equilibrium

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Firm A's price
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\$20 \$15
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Firm B's Price \$20 Firm A earns Firm A earns
\$40 profit \$35 profit
Firm B earns Firm B earns
\$irm 37 profit \$39 profit
\$15 Firm A earns Firm A earns
\$49 profit \$38 profit
Firm B earns Firm B earns
\$30 profit \$35 profit
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a. Firm A and B are members of an oligopoly. Explain the interdependence that exits in oligopolies using the payoff matrix facing the two firms.
b. Assuming that the firms cooperate, what is the solution to the problem facing the firms?
c. Given your answer to part b, explain why cooperation would be mutually beneficial and then explain why one of the firms might cheat.

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Solution Preview

a. There is a clear interdependence between the two firms. Firm A earns the maximum when it prices at \$20 while Firm B prices at \$15. The profits of Firm A are dependent on Firm B's price. Similarly, Firm B earns the maximum when it prices at \$20 while Firm A prices at \$15. It is clear that it is in the best interest of both firms to price their product at \$20 each. However, if both firms price at \$20, then none of the firms will obtain the highest profit. Thus, there is a ...

Solution Summary

The solution goes into a great amount of detail regarding the question being asked. Step by step explanation is provided for each part of the question which makes it very easy to follow along for anyone with just a basic understanding of the concepts. Overall, an excellent response to the question being asked.

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