Question

In the table below, firm 1 and firm 2 can cooperate to share market profits or compete with each other. The figures in the cells represent the profits in crores of INR. They can either cooperate with each other where they share INR 10 crores equally. Alternatively, they can compete, which lowers the market output to INR 4 crores, which they share equally. If one of the firms competes while the other cooperates, the former obtains INR 10 crore of profit while the other makes zero profit. In equilibrium, firm A and firm B should respectively:

Firm 2	Cooperate	Compete
Firm 1	5, 5	0, 10
Compete	10,0	2, 2

• A. cooperate and cooperate
• B. compete and compete
• C. compete and cooperate
• D. cooperate and compete

Hint:

Think about each firm's incentives.

Answer 1

The Correct Option is B

This scenario illustrates a Prisoner's Dilemma game in economics, where firms must choose between cooperating or competing. The dominant strategy for each firm is to compete, as a firm earns a higher profit (INR 10 crores) by competing while the other cooperates, compared to earning zero if it cooperates while the other competes.

The Nash equilibrium is reached when both firms choose to compete, with each firm earning INR 2 crores. Despite the potential for greater collective benefits through cooperation, each firm has an individual incentive to deviate to maximize its own profit.

Thus, the correct answer is (b) compete and compete.