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The Oligopolistic Pricing Problem a Suggested Price Freeze Remedy

The Oligopolistic Pricing Problem a Suggested Price Freeze Remedy

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Published by Mekbib Mulugeta

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Published by: Mekbib Mulugeta on Jul 12, 2012
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07/12/2012

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 WW
OORRKKIINN 
PP
RROOGGRREESSSS
 
T
HE
O
LIGOPOLISTIC
P
RICING
P
ROBLEM
 
A
 
S
UGGESTED
P
RICE
F
REEZE
R
EMEDY
 
Guy Sagi
 
 2
I
NTRODUCTION
 
The problem of oligopoly pricing has long challenged both economic and antitrusttheory. While economic theory attempts to explain how firms set their prices in oligopolymarkets, antitrust theory seeks to construct an effective remedy for what is believed to bea predominant problem of monopolistic pricing. So far these attempts have been onlypartially successful. Although economic scholarship has made significant advances inrecent years, especially in developing models based on modern game theory learning, westill do not hold conclusive or definite answers on oligopoly pricing. Antitrust theory, forits part, is still struggling in its quest for effective remedies.In this paper I set forth an antitrust remedy for the oligopolistic pricing problem.This remedy builds on previous work concerning price and quantity freezes, mainly in thecontext of monopolization by predation. This work, primarily by Williamson and morerecently by Edlin, basically suggests that new entry to a monopolistic market wouldfreeze the pre-entry output production level or the pre-entry price of the incumbentmonopolist. This would, arguably, encourage new entries by firms as well as more pre-entry output or lower pre-entry prices. In this paper I propose the implementation of aprice freeze scheme in oligopoly markets by which an oligopolist that significantlylowers its price would freeze its rivals’ prices at their previously higher oligopoly levelfor a defined period of time. This price freeze scheme, as I will demonstrate later on,would drive prices downward and create an incentive for oligopolists to set ax ante lowerprices.Part I provides a general background on the problem of oligopoly pricing. ChapterA presents the various economic models of oligopoly pricing starting with the staticversions of the Cournot model, continuing with Stigler’s cartelistic approach, and closingwith dynamic repeated game theory models. Chapter B reviews the current deficient legalframework, and chapter C discusses the two major suggestions for resolving theoligopolistic problem: Posner’s economic-evidence approach and the deconcentrationapproach.Part II presents the theoretical model of the suggested oligopoly price freeze. Istart in chapter A by presenting the previous price and quantity control suggestions upon
 
 3which my model is based. I will then develop, in chapter B, the theoretical model of thesuggested price freeze and discuss its expected effect on oligopoly markets.Part III presents the detailed implementation scheme of the suggested oligopolyprice freeze, in which I try to adapt the theoretical model to actual real-world industries.Chapter A addresses the various potential problems and inefficiencies associated with theimplementation of a price freeze in oligopoly markets and discusses how they could beeliminated or at least minimized. Chapter B defines the markets in which the suggestedprice freeze should be implemented. Chapter C presents the detailed suggested pricefreeze, and chapter D presents an example of a major real-world industry in which thesuggested price freeze could have been successfully implemented and could have had asignificant impact on firms’ prices and output decisions.
I.
 
O
LIGOPOLY
B
ACKGROUND
 
Economic theory provides us with unambiguous predictions about pricing andoutput decisions in competitive or monopolistic markets, while it fails to do so when itcomes to oligopoly markets. In markets with a large number of small firms, an individualfirm cannot affect the market price because of its insignificant size. In pure monopolisticmarkets, the monopolist can set the output and the price independently as there are norivals to consider. In contrast, in oligopoly markets, each oligopolist’s decision has thepotential to affect its rivals’ sales. The oligopolists, as they are aware, are thereforeinterdependent. Their basic difficulty is then uncertainty regarding rivals’ actions andreactions. To maximize profits, each oligopolist must correctly conjecture its profit-seeking rivals’ strategies. Economists also have to identify these strategies to understandoligopolistic industries’ performances. In this regard, economists have developednumerous models; some are simple, while others rely on advanced, sophisticatedmathematics.
1
Furthermore, an observation of concentrated markets reveals that pricingbehavior can vary substantially from one oligopoly market to another.
2
 
1
F
REDRIC
M.
 
S
CHERER
&
 
D
AVID
R
OSS
,
 
I
NDUSTRIAL
M
ARKET
S
TRUCTURE AND
E
CONOMIC
P
ERFORMANCE
199
 
(3d ed. 1990).
2
In some industries (such as the cigarettes and the breakfast cereals) the oligopoly firms succeeded inmaintaining prices at a supra-competitive level for many years, while other oligopoly markets havegravitated toward significant price competition.
 Id.
 

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