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
COOPERATE VS DEVIATE
PROFITS depending on
PUNISHMENT
SHORT-LIVED VS LONG-LIVED
ONE-SHOT VS. REPEATED GAME
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.
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
б close to 0
FUTURE IS BLEAK/UNCERTAIN
FIRM PREFER SHORT TERM PROFITS
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.
LIKELY TO COORPORATE
LIKELY TO CHEAT
DIFFERENT COMPETITION MODELS
BERTRAND
CARTEL STABILITY
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
FORGIVING PUNISHMENT (SHORT-LIVED) when punishment is short-lived, the discount factor needed to sustain cartel will be higher; cartel harder to sustain.
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.
SECRET PRICE CUT demand fluctuates and the fluctuations cannot be perfectly observed (price cut cannot be observed)
ASYMMETRIC SHOCKS
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).
EQUILIBRIUM
PRICE WAR DURING HIGH DEMAND when prices are low, firms will have less incentives to cheat (even though the demand is high)
ANTI-TRUST LAW to prevent collusion between firms
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