Collusion

Question 1

Collusion

Answer 1

Collusion exists when firms in an industry or market cooperate to reduce competition. This cooperation can take many different forms.

1. The decision to not compete in the same geographic market. (Example: Coca Cola focuses on the Western European market and Pepsi on the Russian market)
2. The decision to not do research and development in the same technological area
3. The decision to reduce production below a competitive level

Question 2

Explicit collusion

Answer 2

Exists when firms in an industry directly negotiate agreements about how to reduce competition. In most developed countries, engaging in explicit collusion is illegal.

Question 3

Tacit collusion

Answer 3

Exists when firms cooperate in reducing competition but engage in no face-to-face negotiations to do so.

Question 4

Dead weight loss

Answer 4

This loss is equal to the economic benefits foregone by consumers who would buy a product if it was priced appropriately, but do not buy it because the collusive price is greater than the benefits, they perceive from buying this product.

Question 5

Threat of new competitors (collusion)

Answer 5

Firms can collude to reduce the threats from new competitors by working together to increase the barriers to entry into an industry. One way to do this is by incumbent firms cooperating to build very-large-scale production facilities that support their operations but that cannot be expanded to include the operations of new entrants.

Firms can develop common technological standards that make it very difficult for new firms to enter an industry. This is an example of increasing the extent to which cost advantages independent of scale can act as a barrier to entry.

Firms can also cooperate in using product differentiation as a barrier to entry. They do this by reducing their emphasis in differentiating their own products and instead focus on differentiating an industry’s current products as well as potentially new products.

Lastly, firms can even jointly lobby the government to increase the cost of entry into an industry. Joint lobbying efforts can increase the cost of entry into an industry.

Question 6

Reducing threat of current competitors

Answer 6

Collusion with other firms in an industry involves reducing competition among those firms. On the cost side, collusion can enable firms to avoid costly efforts to reduce their production costs, avoid costly efforts to differentiate their products, and avoid costly efforts to make it easy for customers to buy from them.

Question 7

Cheating on collusive agreements

Answer 7

Firms can cheat on the collusive agreements in a wide variety of ways and are based on different assumptions about colluding partners’ reactions to cheating, and they have different effects on the performance of firms in an industry.

Question 8

Cooperation

Answer 8

Both firms maintain agreements

Question 9

Price taking

Answer 9

Both firms ignore alle interdependence

Question 10

Bertrand cheating

Answer 10

One firms assumes other firm will maintain price from previous period: no learning across periods. Decision variable: price

Question 11

Cournot cheating

Answer 11

One firm assumes other firm will maintain quantity from previous period: no learning across periods. Decision variable: quantity

Question 12

Tough signal

Answer 12

Parties cheat on collusive agreements, the firm sending the signal will decrease prices more on increase output more than would have otherwise been the case.

Investing in a new production process that reduces firm’s marginal cost of production.

Question 13

Soft signal

Answer 13

Parties cheat on collusive agreements, the firm sending the signal will decrease its prices less or increase its output less than would have otherwise been the case.

Colluding partner includes positioning a firm’s product so that it does not compete directly with the products of a colluding firm.

Question 14

Puppy-dog-ploy

Answer 14

Maintaining a nonaggressive stance leads others to be nonaggressive.

Investing in a tough strategy is likely to lead other firms to invest in a tough strategy

Do not invest in tough strategies in order to avoid price competition

Ben & Jerry’s delay investing in frozen yogurt

Question 15

Fat-cat effect

Answer 15

Actively investing in ways that others will not find threatening leads others to be nonaggressive

Investing in a soft strategy is likely to lead other firms not to invest in tough strategies

Do invest in soft strategies is likely to lead other firms not to invest in tough strategies

IKEA invests only in wooden, ready-to-assemble furniture.

Question 16

Top-dog strategy

Answer 16

Aggressive strategic investments threaten massive retaliation if another firm engages in aggressive behavior

Investing in a tough strategy is likely to lead other firms to invest in a soft strategy.

Do invest in tough strategies so that competitors know you will respond aggressively if they invest in tough strategies

Korean memory chip firms invest in manufacturing capacity to discourage U.S. and Japanese firms from making similar investments

Question 17

Lean-and-hungry look

Answer 17

Retaining the ability to make aggressive strategic investments has the effect of reducing the incentives of other to make these aggressive investments

Investing in a soft strategy is likely to lead other firms to invest in a tough strategy

Do not invest in soft strategies because they signal your vulnerability to tough strategies pursued by others

HP spins off its electronic instruments business in order to have the managerial resources necessary to exploit opportunities in the computer and printer industries