The Cartel Game!

Student Instructions

B A C K T O

Cartels and Profit Maximization

Pc

D

MC = ACS

Qc Qc

Pc

D

Qm

Pm

Profit

MRQ

P P

A Cartel Tries to Move a Market from “Competition” towards “As if Controlled by a Monopolist”

Q

Competition

As if Controlled by a Monopolist

Your cartel is being watched!

• The class has been divided into four-firm industries that want to act as cartels

• The government wants to protect its consumers from greedy fat cats like you colluding on prices and output.

• The U.S. Department of Justice is watching you and ready to make an example out of you. Here is a video on the bust of a Lysine Cartel.

• To play it safe, your cartel agrees not to meet for the first couple of rounds and act as a non-collusive oligopoly.

Decision Screen• Everyone starts with an output of 10.

• You decide your output reduction. Each unit reduced costs you $1 in profit but creates $2 profit for the cartel ($0.50 profit for you and for each of the 3 members)

• The highlighted column shows your possible earnings based on the decisions of others in the cartel (scroll to see more).

Decision Screen• To move the tokens to the “My Output Reduction” box finger drag each token until you are satisfied with your decision.

• You can move tokens back and forth until you lock in your decision.

• Press and hold the “Done” token to lock in your decision.

WHAT IF? Analysis• Touch the others’ average row to highlight.

• The red box is your round earnings IF you keep your current decision (5) AND IF the others’ group members send the average expected (7) to the “My Output Reduction” box.

Summary Screen• After all decisions you see what others’ average actually is.

• The Industry’s Output Reduction is calculated.

• The total output reduction is multiplied by 2 and split evenly to get your equal share, which is added to your tokens kept = My Profit.

To Collude or Not Collude?

• Let’s try a few rounds where you can meet with your cartel members and collude on an industry output reduction level.

• Option 1: Government legalized your cartel• Option 2: Collusion is still illegal, but they are not

watching you as often– Professor will flip a coin twice for each group. If it’s

heads twice then the cartel will have to act like a competitive industry and not reduce output the next round.

Discussion of the Cartel Game rounds

• Who reduced their output by the full amount? Why?

• Who did not reduce their output? Why?• Who did something else?• Did collusion help more?• Were you willing to take the risk of colluding

and getting caught?

Cartel Problems• The Cartel Interest – reduce output and

maximize cartel profits.– Need coordination to form a collusive agreement,

which is illegal in U.S.– Need cooperation to uphold the collusive

agreement

Cartel Problems• The Self-Interest – increase output and capture more

market share– Incentive to cheat on collusive agreement – Incentive to increase output by a firm in cartel is greater than

for a monopoly because the loss in revenue is split amongst the other cartel, so the net gain in revenue is greater

– Cheating cartel member makes more profits• Retaliation and Cartel Breakdown

– Conditional Cooperation – You cheat, so will I!– Cartel becomes a competitive oligopoly or breaks into a price

war– Good for customers and efficiency, bad for the cartel’s profits

Other Things That Break Down Cartels: Decrease in Market Demand

• What if customers, in their long-run expectation of your cartel’s high prices found substitutes for your product or ways to conserve and decreased their overall demand.

• Now each output unit reduced will produce less industry profit for the cartel = $1.20.

• Incentive to cheat is greater because the opportunity cost of reducing output is $0.70 instead of $0.50.

Other Things That Break Down Cartels: New Entrants and Size of Cartel

• Profits attract the entry of new firms (who may or may not join the cartel) if barriers to entry are weak.

• What if the size of the cartel was increased such that the class only had two cartels instead of several.

• Each output unit reduced will produce the original industry profit for the cartel = $2, but this profit is divided among a larger number of firms.