Question

Imagine Coca Cola and Pepsi produce soft drinks of equal taste and quality. They are the only suppliers of soft drinks to the Olympic Games. They have a stall next to each other where they sell their soft drinks in cans that are specially designed for the event. The Olympic Games last for one week and both companies have to decide once and at the same time how many cans they want to sell.

In competition Coca Cola and Pepsi make each profits of € 180k. Instead of competing against each other Coca Cola and Pepsi could also cooperate and set monopoly quantities as if they would be an integrated monopolist. If both companies cooperate and set monopoly quantities they equally share the monopoly profits. A monopolist would achieve profits of €855 k. If one company is cooperative and the other one deviates, the cooperating company will achieve profits of €160 k whereas the deviating company will get profits of € 530k.
What will be the outcome of the game?

Answer 1

In the game theory scenario involving Coca Cola and Pepsi, the outcome is likely to be competition with each firm earning €180k, as defecting is the dominant strategy for both, leading to a Nash equilibrium.

Step-by-step explanation:

The student's question refers to a game theory scenario involving Coca Cola and Pepsi at the Olympic Games, where both companies must decide on their production quantity.

Given the profits for collusion and competition, the outcome of this game follows the principles of the prisoner's dilemma in game theory, where individual rationality leads to a Nash equilibrium that is suboptimal compared to potential cooperation.

If both companies choose to cooperate and set monopoly quantities, they would each earn €427.5k. If one company chooses to cooperate and the other defects, the defector would make €530k while the cooperator would make €160k. If both decide to compete, each will make €180k.

Given these payoffs, and in the absence of enforceable agreements or repeated interactions that might facilitate collusion, both companies are likely to end in competition, each making €180k, because defecting is the dominant strategy for each firm.