Question: A PRICING MATTER

Consider an industry in which two firms are producing a product. Assume that the two

firms are current "colluding together" to set price so to maximize the industry profit. At

this collusive price, the industry profit is $400 million – and that profit is split evenly

between the two firms. Assume also that if one firm were to cut their price, then the

industry profit would fall to $300 million – and the firm that cut the price would take

75% of the market. Finally, if both firms cut there price the industry profit would fall to

$250 million – and that profit would be split evenly.

1. Is game theory is an appropriate tool for analyzing this competitive situation? If
   so, why?
2. Would you recommend that a firm cut its price or hold to the current price? Why?
3. How, if at all, does this relate to the notion of a "prisoner’s dilemma"?

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