Chapter 23: Problem 34

Game theory predicts that in a market controlled by four firms producing an identical service, each will ultimately charge price. (LO5) a) a high c) a low b) an intermediate

Short Answer

Expert verified

The predicted price level in a market controlled by four firms producing an identical service, according to Game theory, is (c) a low price.

Step by step solution

Understand the Market Setting

We have a market with four firms producing an identical service. In this context, identical means the services provided by these firms are perfect substitutes for each other. Consumers are assumed to have perfect information and can easily switch between different firms when they want to purchase the service.

Review Game Theory Basics

Game theory is a branch of mathematics that studies strategic decision making in competitive situations, where the outcome of a decision depends on the choices made by all players. It involves creating a payoff matrix, representing the different strategies and possible outcomes, and analyzing the best response of each player to the strategies chosen by the others.

Apply Game Theory to the Market

In this market, the firms are players, and their strategies involve choosing a price level to charge for their service. Their goal is to maximize their profit, while taking into account the pricing strategies of other firms. In this context, we would expect price competition among these firms because there are no differences in the product or service they offer to justify a higher price. The firms will try to attract consumers by charging the lowest possible price, while still making a profit.

Determine the Nash Equilibrium

The Nash equilibrium is a set of strategies for each player in a game such that no player has an incentive to unilaterally change their strategy, given the other players' strategies. In this market, the Nash equilibrium would be a set of prices charged by each firm which, if any firm were to deviate from, would result in a decrease in their profit.

Predict the Price Level

Based on the game theory analysis, firms in this market will engage in price competition to attract consumers. As they compete, they will continue to lower the prices they charge for their service, trying to undercut each other. Eventually, the firms will reach a point when they cannot lower prices further without making a loss on their services. The Nash equilibrium in this market would then be a set of prices at which all firms make just enough profit to justify staying in the market and providing their service. Therefore, the equilibrium price level would be somewhat "low" in the market, where profits are minimal but still positive. In conclusion:

Answer:

The predicted price level in a market controlled by four firms producing an identical service, according to Game theory, is (c) a low price.

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