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h A typical monopolistically competitive firm is shown in short-run

equilibrium is at point |

h „utput is qsu where MC=MR,price is s

h Êrofits are the dark blue area.
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h ‘ere the firm is in long-run equilibrium at point |

h |ntry of new firms has pushed the existing firm¶s demand curve to
the left until the curve is tangent to the firm¶s  Ccurve at output
q.
h Êrice is ,and total costs are just being covered.
h |xcess capacity is qC-q

h f the firm did produce at capacityu its costs would fall from  per
unit of output to C.
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h he figure gives a payoff matrix for a two-firm duopoly game.

h ¶s production is indicated across the top.
h ts profits (in millions of pounds) are shown in the blue circles within
each square.
h -¶s production is indicated down the left side.
h ts profits (in millions of pounds) are shown in the green circles within
each square.
h For exampleu the top right square tells us that if - produces one-halfu
while  produces two-thirdsu of the output that a monopolist would
produce:
h ¶s profits will be £22 million
h while -¶s will be £15 million.
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h f  and - co-operateu each produces one-half the monopoly

outputu and earns profits of £20 million as shown in the upper left
box.
h n this co-operative solutionu either firm can raise its profits by
producing two-thirds of the monopoly outputu provided that the
other firm does not do the same.
h Now let  and - behave non-cooperatively.
h  reasons that whether - produces either one-half or two-thirds
of the monopoly outputu ¶s best output is two-thirds.
h - reasons similarly.
h As a resultu they reach the non-cooperative equilibrium.
h ‘ere each produces two-thirds of the monopoly outputu and each
makes less than it would if the two firms cooperated.
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h wo prisoners are interrogated separately.

h hey are told:
h if they both plead innocentu they will get a light sentence.
h f one pleads innocent while the other pleads guiltyu the one who
claims innocence will get a heavy sentence while the other will be
let off.
h f both plead guiltyu they will both get a medium sentence.
h he pay off matrix shows these conditions.
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h -oth prisoners reason as follows

h (1) if the other pleads innocent  am better off to plead guilty and
get off
h (2) if the other pleads guilty  am better off to plead guilty and get
only a medium sentence.
h So the optimal non-cooperative strategy for both is to plead guilty
h his gives them a medium sentence rather than the light sentence that
they would get if they were allowed to consult and agree that both
would plead innocent.