Q2 (12 marks). Two firms are producing diamond, and the normal form payoff matrix is expressed as follows:

Firm 2

Low output High output

Firm 1 Low output 500,500 200,700

High output 700,200 400,400

2.a . What is the pure strategy Nash equilibrium of this game? Is there a dominant strategy in this game? If both firms successfully collude, what would be the equilibrium?

2.b . Suppose the above game is repeated infinitely, and the discount rate in each period is . Each firm uses a trigger strategy in which a firm cooperates ("low output") as long as the other firm cooperates. But, should the other firm cheats ("high output"), the firm responds by cheating forever. Under what condition of can both firms cooperate?