Assume two locally owned used car dealerships that have been in direct competition for many decades. They have a choice of selling high-quality cars at a high price but also high costs because of the repairs that have to be made

Question

The other choice is to sell low-quality cars at a low cost but market them as high quality cars. Explain using game theory why it is in the interest of both of these companies to continue to sell high-quality cars but it may not necessarily be in the interest of a new out-of-town dealership that has recently moved into town to do the same.

Answer 1

Essentially the locally owned firms are playing a repeated game. In this case their reputation matters a great deal. Even if they attempt to sell lower quality cars just once they will have difficulty making this strategy work in the future as consumers get wise to what they are doing. The out-of-town firm does not have the same reputation to preserve. They might not be playing a repeated game and may only be interested in making a quick profit and leaving town.