In the Previous Chapter You Learned About Why Cartels Are

question 64

Essay

In the previous chapter you learned about why cartels are hard to maintain since cheating is a dominant strategy for all firms involved. If this table represents the payoffs for two firms operating as a cartel, are there any Nash equilibria in this coordination game? If so, how many? For these payoffs, what is the "best" equilibrium outcome for both firms? Which outcome is likely to occur in the market? Does your answer change if these firms can communicate and/or monitor each other easily? Explain. $\begin{array}{|l|l|l|}\hline & \text { Firm 1 Cheats } & \text { Firm 1 Doesn't Cheat } \\\hline \text { Firm 2 Cheats } & \text { Firm 1 earns: } & \text { Firm 1 earns: } \\\hline & \$ 4,000 & \$ 2,000 \\\hline & \text { Firm 2 earns: } & \text { Firm 2 earns: } \\\hline & \$ 4,000 & \$ 8,000 \\\hline \text { Firm 2 Doesn't Cheat } & \text { Firm 1 earns: } & \text { Firm 1 earns: } \\\hline & \$ 8,000 & \$ 6,000 \\\hline & \text { Firm } 2 \text { earns: } & \text { Firm 2 earns: } \\\hline & \$ 2,000 & \$ 6,000 \\\hline & & \\\hline\end{array}$

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Definitions:

Equity Method

An accounting technique used when a company holds significant influence over another (associate) but does not have full control, requiring the investment to be recorded at original cost and subsequently adjusted for the investor’s share of the associate's profits or losses.

Sale

is the transaction between two parties where the ownership of goods, services, or assets is transferred from the seller to the buyer for a specified price.

Acquisition Differential

The difference between the purchase price of a subsidiary and the fair value of its identifiable net assets at the acquisition date, commonly known as goodwill.

Consolidated Equity

The total equity of a parent company and its subsidiaries after intercompany balances and transactions have been eliminated.