Consider an Example of the Prisonerʹs Dilemma Where 2 Firms

question 118

Multiple Choice

Consider an example of the prisonerʹs dilemma where 2 firms are making sealed bids on a
Highway-construction contract and each firm is allowed to bid either $100 million or $120 million. If both firms bid the same price, the job is shared equally and each firm earns half the value of its bid. Otherwise the lowest bidder wins the contract and receives the full value of its bid and the other bidder earns zero) . The cooperative outcome in this situation is

• A) both firms bid $50 million.
• B) both firms bid $60 million.
• C) one firm bids $100 million, the other firm bids $120 million.
• D) both firms bid $100 million.
• E) both firms bid $120 million.

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Definitions:

Socially Optimal

A state or condition in which resources are allocated in the most efficient manner from a societal perspective, maximizing benefits and minimizing costs to the society as a whole.

External Benefits

Positive effects of a transaction that affect third parties not directly involved in the transaction.

External Costs

Costs that are not borne by the parties involved in an economic transaction but are imposed on other individuals or society at large, such as pollution or congestion.

Coase Theorem

A principle suggesting that if transaction costs are low, private bargains will efficiently resolve the allocation of resources and distribution of goods.