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from the cooperative outcome by matching the rival’s defection in the next period. It is forgiving in that if the rival returns to the cooperative strategy, tit-for-tat will too.

Coordinating on the Right Price

Within the academic community of game theorists, there is a well-known property of dynamic games called the folk theorem: if firms expect to interact indefinitely and have sufficiently low discount rates, then any price between the monopoly price and marginal cost can be sustained as an equilibrium.21 Of course, strategies other than tit-for- tat would be necessary to generate these other equilibria. For example, one equilibrium would be for each firm to set a price equal to marginal cost in each period. Given that it expects its competitors to behave this way, a firm can do no better than to behave this way as well.

The folk theorem implies that cooperative pricing behavior is a possible outcome in an oligopolistic industry, even if all firms act unilaterally. There can be many other outcomes, however, and thus there is no guarantee that cooperative pricing will emerge. Somehow, each firm in the industry must adopt the tit-for-tat strategy without explicit communication that they intend to do so. To succeed, this cooperationinducing strategy must be a focal point—a strategy so compelling that a firm would expect all other firms to adopt it.

Theories of how focal points emerge in economic or social interactions are not well developed.22 Focal points are highly contextor situation-specific. For example, consider a game called “Divide the Cities” concocted by David Kreps, a professor at the Stanford Graduate School of Business.23

The following is a list of eleven cities in the United States: Atlanta, Boston, Chicago, Dallas, Denver, Houston, Los Angeles, New York, Philadelphia, San Francisco, and Seattle. I have assigned to each city a point value from 1 to 100 according to the city’s importance and its “quality of life.” You will not be told this scale until the game is over, except that I tell you now that New York has the highest score, 100, and Seattle has the least, 1. I do think you will find my scale is fair. I am going to have you play the following game against a randomly selected student of the Harvard Graduate School of Business. Each of you will be asked to list, simultaneously and without consultation, some subset of these eleven cities. Your list must contain San Francisco and your opponent’s must contain Boston. Then, I will give you $100 simply for playing the game. And I will add to/subtract from that amount as follows: For every city that appears on one list but not the other, the person who lists the city will get as many dollars as that city has points on my scale. For every city that appears on both lists, I will take from each of you twice as many dollars as the city has points. Finally, if the two of you manage to partition the cities, I will triple your winnings. Which cities will you list?

There are hundreds of possible outcomes to this game. Yet, when the game is played by American students, the outcome is nearly always the same: the Stanford student’s list is Dallas, Denver, Houston, Los Angeles, Seattle, and San Francisco. The focal point is an East–West division of the United States, coupled with some elementary equity considerations to deal with the fact that there is an odd number (11) of cities to be divided. (Since Seattle is the lowest-valued city, students generally let the western list contain the extra city.) Kreps notes that the focal point of East–West geography becomes less focal when one of the students playing the game is from outside the United States. The U.S. student then often has concerns about the non-U.S. student’s knowledge of geography. The game also loses its focal point when the list of cities has a less natural division, for example, if it contains eight western cities and only three eastern ones.