Suppose two companies own adjacent oil fields. Under the two fields is a common pool of oil worth $60 million. For each well that is drilled, the company that drills the well incurs a cost of $4 million. Each company can drill up to two wells. What is the likely outcome of this game if each company pursues its own self-interest?
A)Each company drills one well and experiences a profit of $26 million.
B)Each company drills one well and experiences a profit of $22 million.
C)Each company drills two wells and experiences a profit of $22 million.
D)One company drills two wells and experiences a profit of $32 million; the other company drills one well and experiences a profit of $16 million.

Question

Quizplus · Accepted Answer

If each company pursues its own self-interest, both companies will drill two wells, each in its own oil field, for a total of four wells. This will cost each company $8 million in drilling costs. The total revenue from the common pool of oil is $60 million, which means that the total profit will be $52 million ($60 million – $8 million per company). Dividing this profit evenly between the two companies yields $26 million per company. However, since each company can only drill up to two wells, they will each drill two wells, resulting in a profit of $26 million per company for a total profit of $52 million. Thus, the likely outcome is that each company will drill two wells and experience a profit of $22 million.

Suppose Two Companies Own Adjacent Oil Fields