Dynamic Models of Oligopoly - Collusion

Question 1

Define a collusion

Answer 1

Concerted actions among oligopolists.

Secret or illegal cooperation or conspiracy in order to deceive others

Question 2

Discuss the gain from collusion

Answer 2

Firms can gain from collusion by producing the Monopoly output to achieve higher profit. BUT incentive to deviate?

Question 3

What to consider when reaching an agreement

Answer 3

• Is there room for market power to grow
• Division of the gain from collusion
• Explicit (cartel) vs. tacit agreements
• Ways of communicating and coordination

Question 4

Discuss the issue of sustainability

Answer 4

The classic oligopoly model predicts that firms have incentives to cheat on a collusive agreement (seen in the cournot model).
However, in a dynamic game, oligopolist interaction is repeated, hence firms should recognise their mutual interdependence and maximise joint profit. Should help with the issue on how to police or enforce collusive agreements - detection, speed and strength of punishment

Question 5

How do dynamic games help to prevent deviation?

Answer 5

Firms can react to cheating behaviour in a multi-period situation through punishment (retaliation) to cheaters.
Threat of punishment must be credible and harsh enough to deter cheating behaviour.

Question 6

What is a super-game?

Answer 6

Indefinitely repeated Bertrand duopoly game with discount factor

Question 7

What is a ‘grim trigger strategy’?

Answer 7

Play the collusive price in each period if all other firms have done so in the past (collusion).
If any firm has ever deviated from playing its collusive price, player Bertrand price (punishment)

Question 8

Factors influencing the sustainability of collusion

Answer 8

Public prices, number of competitors, lumpy infrequent orders, product differentiation, cost-conditions & capacity utilisation, elasticity of firm demand, multi-marker contract

Question 9

What makes collusion easier to achieve?

Answer 9

Small number of firms in the industry, market demand is not too variable, significant barriers to entry, demand is fairly inelastic, each firm’s output can be easily monitored (this is important!) – This enables the cartel more easily to control total supply and identify firms who are cheating on output quotas.