Final answer:
Price-leaders in an oligopoly can use strategies like matching competitors' price cuts but not their price increases, effectively creating a kinked demand curve. This strategy encourages silent cooperation among cartel members, allowing them to maintain higher prices and profits without a legally enforceable agreement, avoiding the Prisoner's Dilemma scenario.
Step-by-step explanation:
Strategies of a Price-Leader in Game Theory
In the context of game theory, a price-leader in an oligopoly market can employ several strategies to maintain market dominance and profitability. One effective strategy is to establish a kinked demand curve by matching all price cuts of competitors but not matching price increases. This can lead to a form of silent cooperation among the oligopolists, where they effectively act as a monopoly.
For example, consider a firm in a cartel that agrees to sell at $500 for 10,000 units. If the firm attempts to increase profits by lowering its price to $300, it will sell more units, but the overall profit might be less due to precipitous price cuts from competitors. Conversely, if the firm tries to increase the price to $550, sales would drop significantly as competitors maintain their prices, resulting in a loss of market share for the price-raising firm.
By matching price cuts, oligopolists signal to each other to maintain output and prices at a certain level, keeping the market stable and, in turn, allowing each member of the cartel to share in monopoly-level profits without a legally enforceable agreement. In such scenarios, members of the cartel can avoid the temptation to undercut each other, which might lead to a breakdown of the cartel and result in zero economic profits, likened to a Prisoner's Dilemma situation.