Economics of Regulation Collusion

8/13/2019 Economics of Regulation Collusion

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Economics of Regulation and

Antitrust

Collusion


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Oligopoly

A. Few Sellers / RecognizedInterdependence

B. Cournot Model

Firms choose quantity

Assume that other firm does change output

Example compared to PC and Monopoly


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Oligopoly - Bertrand Model

Firms choose price rather than output.

With identical goods and constant MC, then

P=?

If products are differentiated. - Example


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Oligopoly - Chamberlin(Monopolistic Competition)

Criticized Bertrand and Cournot modelsbecause they failed to recognize their

interdependence. He argued that intelligentmanagers would know where the profit-maximizing price is and would be reluctant toreduce price and leave all members of the

industry worse off.


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Oligopoly - Stackelberg Model -Price Leadership

Designate one firm as a dominant firm and all theother's in the industry follow this firm's cues. I.e.one firm announce price changes and all the othersfollow.

Examples

Automotive industry

Banking Industry


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Oligopoly - Stigler's Theory

Incentive to collude is strong so as tomaximize joint profits but so is the

incentive to cheat. If any member cansecretly violate the agreement, he will gainlarger profits than by conforming to it.

Therefore enforcement, i.e. detectingsignificant deviations from the agreed-upon prices, is paramount


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Stigler example

Suppose 3 identical firms with zero costs ,facing a market demand curve of Q=180-5P.

The monopoly price and quantity is $18 and90 and the three firms agree to each supply30. The $1620 industry profits are split

$540 to each.


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Oligopoly


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Oligopoly

d is the demand curve when everyone knows(everyone makes 533.33), d' is when there are

secret cuts(if offered to all his customers then$640, if only to "new" customers - $700), d'' issecret cut that steals away other firms customers

without the other firm reacting - $800).

Conclusion - there is a great temptation tosecretly cut prices. Key is detection andresponse.


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Oligopoly - Game Theory

Prisoner's Dilemma - Two suspected criminalsButch and Sundance are arrested and put in

separate cells unable to communicate. If oneconfesses while the other does not, the one whoconfesses is granted immunity and goes free andthe other goes to jail for 20 years. If both confessthey both go to jail for 5 years. If both are silent,both go to jail for only one year, for a lesser crime(concealed weapons). The payoff matrix lookslike this:


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Oligopoly

Whatever Butch does, Sundance is better off confessing.Whatever Sundance does, Butch is better off confessing.Both they are both better off if they both remain silent. Howcan this be?

Sundance

Butch Confesses Remains Silent

Confesses (-5,-5) (0,-20)

Remains

Silent

(-20,0) (-1,-1)


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Oligopoly

Duopolist's Dilemma

Dominant Strategy is to cut price but both firms are betteroff by fixing prices.

Firm A

Firm B Cut Price ($12) Fix Price ($18)

Cut Price ($12) ($720,$720) ($1440,0)

Fix Price ($18) (0,$1440) ($810,$810)


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Can Collusion be beneficial?

It reduces uncertainty in profit rate , demanduncertainty in the face of production

indivisibilities Example


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Can Collusion be beneficial?

Indivisibilities in production.

Other problems - large fixed and some avoidable

costs with uncertain demand.


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Public Policy toward Oligopolyand Collusion

Section 1 of Sherman Act declares everycontract, combination, or conspiracy in

restraint of trade illegal. Price-fixing andrelated practices were judged illegal perse i.e. in and of themselves. There is to

asking of whether there were extenuatingcircumstances no test of reasonableness

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Economics of Regulation Collusion