The corresponding pay-offs (profits) are given in the boxes. In this game, the best thing that can happen for a firm is to produce a high level of output while its rival produces low. Low output of the rival provides that price is not driven down too much, thus a firm could earn a good profit margin. The worst thing for a firm is to change places with its rival assuming the same situation takes place. If both firms produce high levels of output, then the price would be low, allowing each of them to earn still positive but very small profits. Nevertheless, (HIGH;HIGH) would be the dominant strategy of this game (we would observe a Nash equilibrium in strictly dominant strategies here). It is the best response of firm A whenever B produces a high or low output and this is also true for firm B. The non-co-operative outcome for each firm would be to get the pay-off of 1. But as we can see, it would be better for both to lower their output and thereby to raise price, as their profits would increase to 2 for each firm instead of 1 in NE. Strategy (LOW;LOW) would be the collusive outcome. The problem of collusion is for the firms to achieve this superior outcome notwithstanding the seemingly compelling argument that high output levels will be chosen. This was an example of a "one-shot" game and we saw that the collusive outcome was not available for that case. But in reality these games are being played over and over (on a long-term basis) and we will see later in this essay how the collusion can be sustained by threats of retaliation against non-co-operative behaviour.c.) Predatory pricing. Here we need to introduce the explicit order of moves in the model. There are again two players-firms on the market- an incumbent firm and a potential entrant in the market. The game is illustrated below: The potential entrant chooses between entering and staying out of the industry. In the case of his entering, the incumbent firm can either figh...
