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EXAMPLES

Cl1aracleris~i cs 1) IExiP1r~it 'coopernnve agreentenls 10 set p~~e,'above, " c,ompetiffi,' '8 tevets and (S",Tllme,tm:allyj'lo constrain OU~I'l'LJt belm'f cornpetlffve levels :2) IMev not inclulfe ,all firms i~,ttle induslrry ,3) Formal eartets me mosl ITeqw8~tly observed oUllside Hle U,S. because they lnave,reell i:lleg!!ll~Il 'the US. smee 1-aso. ISe elion 1 oj snerman Anlitrusl,Acl-·- c~min31 and c~v[1 penHlli~l 4) IS"I,&ecrel pri:reiixingl, markel,diViSion andre I,aled,eff:a,rts,ID-ii:<: prices occur I~Hle 'U,5. as urell: Tne !LS, Department of ,JuiSliceIJroug ht over '6[)() crimiool priDe~xing cases between ~991 and 2002 ---- lA'on 95Pk 5) IP~Joe fixingl ag:reemenls are often unsuccessful orr- 10nol ~ast 1m )le!"" 1 longllmt firms keep trying: cheating cornpefftive entry getling caught b)l e~lc:rcelllent agencies,

I'niernationa'i cartels (oftell involving gov,ernmenls) - OPEC - Bam;:ile

- Tin
- Diamonds - Uranium - Coffee

EXAM PLIES
Racent U.S. Price Fixililg and Market Division Agreemenls • fliu:clio Il houses
iP'

I PRICE

ASSUME 3 COMPEifITIVE TAKBRS

IFIR,MS THAT ?,R,El

I

• Asphalt co ntraets
• Road construction bids
MG3

• Ivy iLeagu:e and MITfinall(ial • Willol'esale vitamins • IVril~ [sanctioned

<lid rOven-l"p")
MC~ E=inrfl ~

I

MC.2 Firrn Z

by special laws]

• Liquor and wiime sales (sanctioned

by special laws]

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ave to close down to produce QM effficiellfilly • How dO'we convince Firm 3 to participate? IMust transfer some ot litil.~!~tprice cuts could be very profitable • How db we keep firms from cheatinq and leadinq the cartel to .e monopoly profits • With P> IM:C. ID Q COLLUSION • Ilfthefirms could colju die successfusyand charqe monopoly prices their aggreg!aie profits would rise • Oulput would have to fa!:! and in this case Firm litil!ree wOUJldItil.small ~.p ASSIYME 3 OOMPETITIVE Pi1:IC£ifAKERS FIR~1S THAT ARE p ASSlJME ACHIEIIE THEa FIRMS OOUUDE AMD SEEK TO MGMOPOl Y PRIOES ANOCPROFIifS P.wllaJpse? The OPEC Oil Cartel 2 .

3 . the government permtted six New IEnglarnd slates to form eli milk cartel INo:rtheast lnterstate Daiiry Compact -.S .are sometimes tacilitsted by govemment acticns resulting from interest g~oup' pressures • 1990s with less govemment support.NIDC) '. 7 in 16 Southern states to form eli new regional cartel..TO is inelastic .DOPEC is relatively inelastic Cartels • ObservaHo:rls . ihe price of milk fluctuated more wide!ly '.r the ca li1e must controlnearly all ot the I world's supply or the supply 01 non-cartel producers must not be too price' e'l slilc a • Cartslmusf be able to tidenlilfy and "punish" cheaters (sornefirnespovernruent policy enforces the cartel agreement) • Some way may have 10 be tound to compensate higl'nlcost suppliers 10g'et them 10 shut down supply In a'ilow join! profits 10 be maximiz.The OPEC Oil Cartel • Abo~~OPEC -Very low Me . Cartels in the U.ed The Milk Carte: '. lin response. 199.g legislation allowed dairy ffairmers irnl Northeastern states surreundinq INIIDe to join IN~DC.To be successful: • Total demand must not be very price elasnc • Entlie.Non-OPEC at least supply lis inelastic in the short run .

-10 f-- f----------1 Wo uld you c:i~oose 10 .2 Charge $4 Charge . f • scenarle . -1 -2. -5 PTisofle. . -2 4 . illustrates the problem O:ljigopo~lis~icirms face.~fess? -10. (dose but not perfect substituies] • Wiley wOUlI.dllli'keloestablish a co'llu1siveset of prices but cannot ..onerB Do~1't:confess -5.S2ID $16. Payoff MatrixWor Prjic~ngl ame G Firm .is.IEElchhas been askedto COi1[€SS to the crime.COLLUSION AND THE PRISOINERS' DILEMMA Assume lli'n<ltIIIe n.$16 Ccmpetltton Versus Collusion: The Prisoners' Dilemma • An example in game theory. called ~he Prisoners' Dilemma..rA Do~1't ~o~fess -1.co.'e two competinqtrms selii'mg dilierellli ..$4 Firm 1 Qlirne"strategies: Charge $6 S4. Payoff Ma]rixfor Confess Prisoners" Dilemma P.$12 $20.ted l products.Two prisoners have been accused of co llaborati i19 iill a cri nne.enter into <I bimling agrnementm communicate directly..$6 Charge $4 $~12. .Theyare in separate Jail!cells and cannot communicate.

irms cO'lll1lJeIe oufputor quantities (which in lmn leads tn lin eq. .adion curves "re dow.perfect competition and monopoly the producers did not have to consider a rival's response whell chcosin g ouip ut an d pries.ullilbflum prices) • Nash IEquiHbrium ..Defi!1ing Equilibrium • Firms doi:ng the best they can and hiaving no incentive to dha:n~:e(deviale)i from the OUIPllt or price iJ·al !Iley have chosen • All firms assume competitors are tak.adh firm chooses the output '~q uantilty) that rnaximizes pmffils given.Binding collusive agreeme.iolil? -[Ilis is whalllloTn-oooperative o'ligopoly !hemi)' lis all about Non. .iorill a stralegi.eg.[mplicit collusinn ill which a firm announces <I pries increase in lihe hope fhal other firms will follow suit Non-Cooperative • Equilibrium in Olin Oligopoly OligopoHsliic Manket • Price Leadership .lrnpllcations of the Prisoners' Dilemma.o'llg opoly the producers m ust consider th.ing their rivals decisions irnlo account.Cooperative Oligopoly • IEqUiiiiliibriUlm en Oligopolistiic Market in .e strateg:lc rasponse of competitors wihen choosinq output and price.il rnaximizinq output give!1 TIlleoutput of the other firm Re.Pattem 01 pric~ngllin which one firm regularl/i announces price challges that otherfirmsthen match .differeflt cost lunctio~s • Behavioral! assumptions E. They are also III.I1lw rd sl~opil1gin the output a 01the rivsl fi rm 5 . .~ifficul!lo creat~ and eriforce.Each firm is doi!1g the best it can given what its cornpetitnrs me doing.Wil:h.e . Firm's Best Respo!1lse givern competitors' actions. • Eadn firm has a "best response function" or "reaction curve" defininq its prof. F.Can nOIil-wopemtiive Ibe'hilN.ntsar. T\'ro firms.1 mal1lYcountnes In.competing with each other • Homoge~oueSgaoo • Fimn~ ma:y rnmre . COURNOT OLIGOPOLY MODEL • The Cournct Oligopoly Model! .Witih. . tile output ofits rival.e behavior may be more comp licated than timecompetitive iri:rng'eill dorn inant firm model .DUQPo:lyCase . for OHgopolistiic Pricilng Communieations between firms seeking to coordinate is i:mpod<lnt • Price S~gnal:jrng .Competitors stralegi. .e se-ttililg lsad to outcomes IIItlthi Ihigher prices and profits than lin dar lPerfeet co I1rTI petil.

2Q1= 10 Firm 1.5 lMarg inal revenue = 30 .(:" '(Ill J.Q wlhe~e 0= Or + O2 • Mel MG2 0 ...02: .+ MR = IMC=+ ==... Q2= 5 310.a ctiibn C urves and coumot Equilibri~m • An Example of the Cournot Equilibrium with linear demand ..O2 Profit Max .IDuopoly 2 firms selling hcmoqeneous products wiih IMC= 0 (fixed costs only) • Markel: (inverse) demand is P = 30 ..0.h j.•{:(.+ Q1 = 15 .( Q. R!e.(... ~ ~ t! 1·11 I Illf I ":: I' II .'01Q2- Q12 Firm 1.Firm 11 Output Decision 's NASIH-COURNOT EQUILIBRIUM • The Nash equlllbnum ii!ln COli mot model a iilS the point where both! firms are O~!~heilr rsacflon curves alnd neiiither 'Cilln do better by challgiingl iits output gliven the oufput IQf til e other fi rm • The firms" assumptions about what theiir rival iis doing are consistent • This is ~he point where the readiiot'l! curves cross f~·'~i .ii: :l.5 Reaction Curve 6 .Firm 1'5 Reaction Curve: Total revenue = PQ1= (30-(Q~ + = = '02 - »)Q1 2Q~ = 3001 .

Firm 2"5 Reaction Curve is given by: COURNOT DUOPOLY lFirm2's Real!:.' But how much woulid each firm produce? = TIR - Fixed Costs = 20[1- Fixed Costs 7 .u'ilibriurn 1@ Cournot Equilibrium: Q. = Q2 15 -1/2(15 -lj2Q]) = 10 Q= Q.Q' = 3 O .. + Q2= 2'0 P=30-Q=10 Profits Compal1e to Profit Maxiimization with Coillusio:n R = PQ = (30-Q)Q = 30Q1 Ql MR = t1R/ l'.tf-em C!JT'i'~ CaumDt Eq.225 .2Q MR = 0 when Q = ill ): and j'rJR = Me P = 30 . and since the firms have the same rnarqinal cost functions.Fixed costs .By the same reasormq.Q =+ P= 15 TiR= 225 Profits = .

ColJusiJ.libriUrm : . 1D lRirm2's IR'eJI!:. prom = o~ • Less output andllhi ghen-profits thanthe equilibrium Cournot --~a:::ol!JmOiIEqUi.I Compal1e to ..QTI -!I- Profit Maxill1izationwith Collusion I Duopoly Example 0.re. Equil:ibfiUll1l 8 .QTI = Q = 7_5 2 C"".peti~i"" 16qp'ilibriurn W = Me.U:-em C!JT'i'~ • contract curve Q2= 15 • ShQWS a'II pairs 01 oulput 01 and Q2t:hat maximizes total p refits .