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IAI Actuarial Core Principles · Business Management · Decision-making process, attitude to risk and competition

A large Indian insurer repeatedly competes with a rival over many years in the same market, with no known end date. Both would gain from avoiding price wars. Which feature of repeated games most helps tacit cooperation on prices to be sustained?

Tacit cooperation is sustained when the threat of future retaliation outweighs the one-off gain from undercutting. In an open-ended repeated game, a deviation can be punished in later periods, so each firm finds that maintaining prices gives higher long-run payoffs.

  1. AThe threat of future retaliation outweighs the one-off gain from undercuttingCorrect
  2. BA one-shot dominant strategy to undercut becomes stronger
  3. CPlayers can no longer observe each other's past moves
  4. DPayoffs become zero-sum over time
  5. Each firm is forced to choose a mixed strategy

Explanation

In repeated play, a firm that undercuts can be punished in later rounds, for example by a price war. If the future matters enough, the short-term gain is smaller than the discounted loss, so cooperation can be an equilibrium. Observability of moves is needed, so the option removing it is wrong.

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