Suppose the agreement is Russia and South Africa each produce 3000 each and the

# Suppose the agreement is russia and south africa each

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Suppose the agreement is Russia and South Africa each produce 3000 each, and the market price is 7 , 000. Now Russia decides to cheat on the agreement and produce 4000. At a market output of 7000 (=4000+3000) the market price would be P = \$6000. Russia in this case would make a profit of \$6000 × 4000 - \$1000 × 4000 = \$20 , 000. Before their profit was \$7000 × 3000 - \$1000 × 3000 = 18 , 000. Thus, Russia would have an incentive to cheat by earning profits from producing more, hoping that South Africa would stick to the agreement. However, South Africa has the same incentive. Moreover, notice that cheating on the Cartel agreement is a Nash equilibrium. From 11
South Africa’s perspective, if they think Russia is going to cheat, then they have an incentive to cheat as well. If they think Russia isn’t going to cheat, then South Africa has an incentive to receive more profits by cheating. So, South Africa will always want to cheat (it’s a dominant strategy). But, this game between Russia and South Africa is symmetric, so Russia also will always want to cheat. So they both cheat, even though they would be better off by not cheating. Thus, this simple duopoly example of a cartel illustrates the same challenges of preserving cooperation that is illustrated in the Prisoner’s Dilemma game. 12

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• Spring '08
• SamuelMendez
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