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COLLUSION (CARTEL STABILITY) (COOPERATE VS DEVIATE (PROFITS depending on,…
COLLUSION (CARTEL STABILITY)
NATURE
HIGHER INDIVIDUAL PROFITS
when firms work together instead of competing vigorously e.g. setting monopoly price in the case of Bertrand
ANTI-TRUST LAW
to prevent collusion between firms
COOPERATE VS DEVIATE
PROFITS
depending on
PUNISHMENT
SHORT-LIVED VS LONG-LIVED
ONE-SHOT VS. REPEATED GAME
FORGIVING PUNISHMENT (SHORT-LIVED)
when punishment is short-lived, the discount factor needed to sustain cartel will be higher; cartel harder to sustain.
DISCOUNT FACTOR, б
measures the present value of $1 in period's time. NOTE: 0< б<1
б close to 1
FUTURE IS IMPORTANT
FIRMS PREFER LONG TERM PROFITS
LIKELY TO COORPORATE
б close to 0
FUTURE IS BLEAK/UNCERTAIN
FIRM PREFER SHORT TERM PROFITS
LIKELY TO CHEAT
CRITICAL DISCOUNT FACTOR
the discount factor where the profits from both cooperating and cheating is equal; if б fall below the critical value, firms will deviate.
FACTORS THAT AFFECT б
OPPORTUNITY COST OF TIME (INTEREST RATE)
FREQUENCY OF INTERACTION
no of price change; the more frequent price changes are, the easier to sustain cartel (б closer to 1)
EXISTENCE OF INDUSTRY
whether profits would be received in the next period e.g. if 2 pharmaceutical were to collude they need to consider the likelihood of another firm producing a superior drug which will bring the first 2 firms out of the market. Hence the higher the probability of existence, the easier to sustain cartel (б closer to 1)
E.G. RATE OF INNOVATION
INDUSTRY GROWTH
whether the industry is likely to grow; if the industry is likely to grow, the profits in the next period is likely to be higher and therefore easier to sustain cartel. (б closer to 1)
E.G. PRODUCT LIFECYCLE
NO OF FIRMS
the more the number of firms, the higher the б needs to be for collusion to hold. Thus, the more firm there are, the harder it is to sustain cartel
TRIGGER STRATEGY
usually in a repeated game, one party begins by cooperating in the first period and continues to do so until its competitor deviates.
DIFFERENT COMPETITION MODELS
BERTRAND
CARTEL STABILITY
FACTORS THAT FACILITATE COLLUSION
STRUCTURAL FACTORS (MARKET STRUCTURE)
MORE SUSTAINABLE
BETWEEN SIMILAR FIRMS
easier to sustain cartel when the firms are similar e.g. in term of cost structure.
IN CONCENTRATED INDUSTRIES
easier to reach agreements when there are lesser competitors
INSTITUTIONAL FACTORS
RULES AND REGULATIONS
e.g. clauses to protect consumers stating that firms need to charge ALL consumers at the SAME price for a specific time period. Thus, firms has less incentives to undercut prices fearing that the penalty of refunding previous customers who were charged a higher price
FIRMS COLLUDING IN MORE THAN ONE MARKET
PRICE WAR MODELS
DEMAND FLUCTUATIONS
when the state of demand is observable. When demand is high, the gains from cheating on the cartel is greater.
EQUILIBRIUM
PRICE WAR DURING HIGH DEMAND
when prices are low, firms will have less incentives to cheat (even though the demand is high)
SECRET PRICE CUT
demand fluctuates and the fluctuations cannot be perfectly observed (price cut cannot be observed)
LOW DEMAND DUE TO
RIVAL UNDERCUTTING PRICE
MARKET DOWNTURN
SOLUTION
OCCASIONAL PRICE WAR
move into a price war for T periods upon experiencing low demand and then revert to collusion after that (otherwise the incentives to cheat is too big).
ASYMMETRIC SHOCKS