Nash Equilibrium

In Table 11.2, each firm's secure strategy is to offer a discount price regardless of the other firm's actions. The outcome is that both firms offer discount prices and earn relatively modest profits. This outcome is also called a Nash equilibrium because, given the strategy of its competitor, neither firm can improve its own payoff by unilaterally changing its own strategy. In the case of Coca-Cola, given that Pepsi-Cola has chosen a discount pricing strategy, it too would decide to offer discount prices. When Pepsi-Cola offers discount prices, Coca-Cola can earn profits of $4,000 rather than $1,500 per week by also offering a discount. Similarly, when Coca-Cola offers discount prices, Pepsi-Cola can earn maximum profits of $2,000 per week, versus $1,000 per week, by also offering a discount.

Clearly, profits are less than if they colluded and both charged regular prices. As seen in Table 11.2, Coca-Cola would earn $12,500 per week and Pepsi-Cola would earn $9,000 per week if both charged regular prices. This is a business manifestation of the Prisoner's Dilemma because the dual discount pricing Nash equilibrium is inferior from the firms' viewpoint to a collusive outcome where both competitors agree to charge regular prices.

Of course, if firms collude and agree to charge high prices, consumers are made worse off. This is why price collusion among competitors is illegal in the United States, as discussed in Chapter 13.

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