The Principle of Equilibrium in Business Competition
How is equilibrium established in a business situation where two firms assume the other will compete and charge a lower price?
a. Widget Co. charging the low price and Ajax Co. charging the low price
b. Widget Co. charging the high price and Ajax Co. charging the low price
c. Widget Co. charging the low price and Ajax Co. charging the high price
d. Widget Co. charging the high price and Ajax Co. charging the high price
Answer:
The equilibrium in this business situation, known as the 'Prisoner's Dilemma', will be established when both firms, Widget Co. and Ajax Co., charge a low price due to the assumption that the other will compete and charge a lower price.
The situation you've described is an example of game theory in business, specifically a situation known as the 'Prisoner's Dilemma'. This occurs when two companies, in this case, Widget Co. and Ajax Co., could potentially earn higher profits by cooperating and mutually deciding on a high price. However, because each firm does not know what the other will do, they both assume the other will undercut them to gain more market share and thus they both set a low price.
This results in a situation where both companies charge a low price, an outcome that is less profitable for both. So, the equilibrium will be established by Widget Co. charging the low price and Ajax Co. charging the low price, which corresponds to option (a).