Chapter 9 - Collusion and Price Wars

Question 1

collusion

Answer 1

alternative solution such that all firms are better off (at the expense of consumers

Question 2

cartel agreements

Answer 2

particular institutional form of collusion with the objective of restricting supply (or increasing price)
generally illegal

Question 3

tacit agreement

Answer 3

derives from the common intention of the parties and is inferred from the terms of the contract and the surrounding circumstances.

Question 4

Nash-Bertrand equilibrium

Answer 4

playing a repeated game, ignoring at each stage what the previous history of the industry was (set prices at P=MC)

Question 5

grim strategies

Answer 5

a rival’s cheating triggers the punishment phase,
if one player defects, both players are supposed to always defect
Example:
In the first period, both firms set price at the monopoly level, and share monopoly profits equally (1/2π). In each subsequent period, firms observe the price history before setting their own prices. Firm 1 will set P=Pm so long as Firm 2 sets P=Pm as well. The moment Firm 1 observes its rival setting a different price, it “punishes” the deviation by reverting (forever) to price at the marginal cost level

Question 6

discount factor

Answer 6

the value of 1$ in one period into the future compared to 1$ now

Question 7

δ ≥ 1/2

Answer 7

if the discount factor is sufficiently high, then there exists a Nash equilibrium of the repeated game whereby firms set monopoly price in every period under the “threat” that, if any firm ever deviates from this price level, then both firms revert to pricing at marginal cost level forever

Question 8

collusion is normally easier to maintain when firms interact frequently and when the probability of industry continuation and growth is high

Answer 8

Question 9

why don’t firms collude more often?

Answer 9

• antitrust policy = binding constraint on the firms’ actions to collude
• if a firm expects to exit the industry with a high probability, its incentives to collude are low, as there is not much to gain in terms of expected future profits
• collusive agreements are not in equilibrium
• not all prices are observed with precision

few real-world collusive agreements work in practice
each firm’s decision involves a trade-off between short-run gains and medium- to long term losses

Question 10

customer markets

Answer 10

industries where each customer is sufficiently large that prices are negotiated on a case-by-case basis

Question 11

collusive agreements in customer markets

Answer 11

although firms may agree on what prices to set, the temptation to secretly cut prices for a particular customer is large

Question 12

although price wars occur in equilibrium, no firm cheats in equilibrium

Question 13

if price cuts are difficult to observe, then occasional price wars may be necessary to discipline collusive agreements

Question 14

collusive equilibrium

Answer 14

firms have no incentive to undercut their rival’s price
the difference between future collusive profits and future profits in case of a price war must be sufficiently large to deter a firm from pursuing the short-term gains of the cheating on the collusive agreement

Question 15

prices move counter-cyclically

Answer 15

price wars take place during booms
to achieve an equilibrium, it may be necessary to reduce price during the periods of high demand. If price is lower, the gains from cheating are also lower in periods when demand is higher

Question 16

Collusion is normally easier to maintain among few and similar firms

Answer 16

it is easier to establish and maintain a collusive agreement when there are few competitors (high concentration)
it is easier to maintain collusion among similar firms than among asymmetric ones

Question 17

collusion is normally easier when firms compete in more than one market (rather than versus each other in one market)

Question 18

facilitating practices

Answer 18

rules or regulations imposed by the firms or by the government that may particularly facilitate collusion

Question 19

most-favored customer clauses

Answer 19

clauses that bind firms not to offer a discount to a particular customer without offering the same discount to every other customer within a period of time

lowers the incentive for a firm to cut prices, therefore collusive pricing arrangements are more stable than if no clause is imposed

Question 20

implications with legislations that increase market transparency

Answer 20

may facilitate price coordination

if prices are made public, then monitoring a collusive agreement is much easier than if prices are private information