Question

Sometimes oligopolies in the same industry are very different in size. Suppose we have a duopoly where one firm

(Firm A) is large and the other firm (Firm B) is small, as the prisoner’s dilemma box in Table 10.4 shows.

	Firm B colludes with firm A	Firm B cheats by selling more output
Firm A colludes with firm B	A gets \(1000,B gets \)100	A gets \(800, B gets \)200
Firm A cheats by selling more output	A gets \(1050, B gets\)50	A gets \(500, B gets \)20

Assuming that both firms know the payoffs, what is the likely outcome in this case?

Short answer

Because of the prisoner’s dilemma, they will compete and cheat. When both firms cheat and lower their prices, firm A will earn $500 and firm B will get $20.

Step-by-step solution

Step 1. Definition

An oligopoly is a market with little competition in which a few producers control the majority of the market share and produce items that are identical or homogeneous.

Step 2. Explanation

According to the question both firm A and firm B are in duopoly so they are the only sellers and firm A is larger and firm B is small. Because of the prisoner’s dilemma, they will compete and cheat.

When both firms cheat and lower their prices, firm A will earn $500 and firm B will get $20