Part II: Structural Analysis of the Industry II.2. Oligopoly : collusive and non-collusive models SLIDESHOW 7 Flashcards
On what does the oligopoly theory rest?
Recognition of the importance of the # of firms in the industry and the nature of the product
What is the central problem of oligopoly?
The recognition of the firms’ mutual dependence or interdependence
What does interdependence mean?
A firm is aware that its own actions affect the actions of its rivals
On what does game theory focus?
Uncertainty, interdependence, conflict and strategy
What does game theory show?
It shows that decisions that may appear rational from each firm’s individual perspective can lead to outcomes that are sub-optimal
What is a game that is played only once?
A single-period game
What is a game that is played more than once?
A multiple-period or repeated game
What is a player’s strategy?
A set of rules telling a player which action to choose under each possible set of circumstances
What is a simultaneous game?
A game in which all players choose their actions simultaneously
What is a sequential game?
A game in which the players choose their actions in turn
What is the outcome of a game?
A set of strategies and actions that are actually chosen
What is an equilibrium?
A combination of strategies, actions and payoffs that is optimal for all players
What are the 2 types of games?
1\ Cooperative : players can negotiate a binding agreement
2\ Non-cooperative : when an agreement is not possible
What is a constant-sum game?
Game classified according to its outcome, the sum of the payoffs to all players is always the same
What is a non-constant sum game?
The sum of the payoffs depends on the strategies chosen
What is a zero-sum game?
It is a constant-sum game in which the sum of the gains and losses of all players is always zero. For example : poker
What is the key defining characteristic of a game?
The property of interdependence
How is the best strategy for a player called?
The dominant strategy
When both players have the same dominant strategy, in which situation do we find ourselves?
Nash equilibrium : neither player can improve his payoff given the strategy chosen by the other player
What is a prisoner’s dilemma
There are gains to be made if the players collude
What is a mixed strategy?
A game in which there are no dominant strategies
What is a game tree?
In a sequential game, it is a map of choices facing the players
What is another name for payoff matrix?
Strategic from representation
What is a conjectural variation?
Assumptions a firm makes about the reactions it expects from its rivals in response to its own actions
What is a solution to the oligopoly?
1\ Pure independent action
2\ Pure collusion
When does the possibility of collusion arise?
When multiple rival firms recognize their interdependence
What are the 2 firms of bargaining?
1\ Explicit negotiations
2\ Tacit behaviour
What are the 2 models analyzing strategic interactions between firms?
1\ Model of price determination in duopoly (Bertrand)
2\ Model of output determination in duopoly (Cournot)
What happens in the Bertrand model?
Each firm sets its own price and then sells as much output as possible
What are the characteristics in the Bertrand Model?
The output of the 2 firms is identical and there aren’t any transaction or search costs.
When does the price-cutting sequence in the Bertrand Model end?
When price falls to the perfectly competitive level Pc = Mc. Each firm captures a 50% share of the market at the Pc level
What are the criticisms addressed to the Bertrand Model?
1\ Capacity constraint (Edgeworth) –> no stable equilibrium solution
2\ Lack of temporal dimension
3\ Homogeneity of the products
4\ Closed model
What is objective differentiation?
Related to effective characteristics of the product (transportation costs, packaging…)
What is subjective differentiation?
Related to the brand, the reputation
In Cournot’s Model, how do both firms maximize their own profit?
It is subject to the constraint that the other firm’s output is fixed at its current level
What is the Cournot-Nash equilibrium?
The point at which both firms are simultaneously located on their own reaction functions
What is another solution to Cournot’s duopoly model?
Stackelberg through the leader-follower model. In Cournot, each firm operate according to the zero conjectural variation assumption and fails to anticipate the other’s reaction on each occasion it adjusts its own output
What is an alternative of Stackelberg’s solution?
A first-mover advantage
How do we reach a Stackelberg disequilibrium?
If both firm simultaneously produce the higher level of output. At this point, there is overproduction and firms are forced to cut their prices in order to sell additional output. Both firms earn less profit than at the Cournot-Nash equilibrium
Explain the different time frames between Cournot and Bertrand.
Cournot competitors choose capacities and then compete as capacity-constrained price setters. Production costs are sunk.
What is the conclusion in the Cournot equilibrium outcome?
Positive profits and a price that exceeds marginal and average cost
What is the specificity in Bertrand’s Model?
Markets in which capacity is sufficiently flexible that firms can meet all of the demand that arises at the prices they announce
What brings firms to collude?
Uncertainties and risks
How is collusion seen?
Easing competitive pressure through unified action
What did Machlup draw regarding collusion?
There is an important distinction between degrees of collusion and forms of collusion
What are the 2 forms of collusion?
1\ no formal agreement
2\ explicit agreements
What are the 6 forms of informal collusion?
1\ Industry tradition 2\ Informal expressions of opinion 3\ Exchange information about strategic decisions 4\ Trade association announcements 5\ Similar announcements 6\ Active participation of firms
What are the 3 conditions describing a tacit collusion?
1\ Transparency
2\ Incentive for firms to stick to a common policy
3\ Potential entry and buyer reactions should not be seen by firms as potentially destabilizing threats
What are the 2 main institutions to promote and organize cooperation between producers?
1\ Trade associations
2\ Cartels
Are trade associations tolerated by legal authorities?
They are if they foster competition or at least don’t impede competition
What is a cartel?
A form of organization adopted by firms in an oligopoly in an attempt to achieve a collusive outcome. they seek to enhance the monopoly power (Liefmann)
What is a joint venture?
An association between multiple competing firms
What are the 2 types of joint ventures?
1\ Consortium
2\ Syndicate
–> Joint ventures stimulate innovation
When are usually consortia established?
When firms undertake speculative activities (risk too high and thus discourage individual involvement)
What are the 3 main reasons pushing firms to form joint ventures?
1\ Combine resources to increase efficiency
2\ Enter new market
3\ Develop joint R&D programmes
When does a semi-collusion happen?
In the case it is difficult to formulate specific agreements covering all aspects of the firms’ behaviour
What is the last form of collusion?
State-sponsored collusion to promote rationalization
