Question

Imagine the following hypothetical situation. Two firms, Amazing Chicken and Best Chicken, have become the only suppliers of fresh chicken meat in Malaysia. Both firms are seeking to increase their profits and are considering entering into illicit price collusion by agreeing to charge artificially high prices. Such a practice is illegal and risks heavy fines. Analyse the interaction between the two firms using game theory. Present a payoff matrix to model the situation and analyse it for Nash equilibrium. Which is the best outcome for each firm? Which is the best outcome for society as a whole? What can be done by the firms or government to make society’s best outcome more likely?

Answer 1

There are only two firms in the market and thus there is a possibility of the formation of illicit collusion. This is an example of an oligopoly market structure. Here firms can increase their profits by forming the collusion. If these firms compete, the profits of both will fall. Competition leads to a decline in the profit, but the society at the large is benefitted as the people are able to get the products at a cheaper rate.

Following is the payoff matrix:

		Best chicken
Amazon Chicken		High Price	Low Price
	High Price	19, 19	10, 30
	Low Price	30, 10	16, 16

In the above matrix, the High price strategies by both firms will fetch higher profits equivalent to the $ 19 for each firm, While the low price strategies will reduce each profit to the level of $ 16.

The charging the Low price is the dominant strategy for both firms, thus eventually, both go with dominant strategies and end up getting the $ 16.

The low price strategy would be best for society while the high price strategy would be profitable for the firm.

Such a Malaysian government must declare such collusion as illegal and illegitimate. such action of government would go a long way in promoting social welfare.