Repeated Collusion and Oliogopoly.

motivation, one shot cartel formation, tacit collusion, finite vs infinite, grim trigger strategy, bertrand vs cournot, carrot and stick.

why do firms want to collude?

• raise prices, restricts output and achieves monopoly level profits.

• removes the pressure of rivalry.

why do cartels fail in one-shot?

there is no future punishment and each firm will deviate to gain a short term gain.

what is the free-riding incentive within cartels?

firms may decide to stay outside of the cartel as they benefit from the higher price without the risk of joining.

why is collusion unstable?

short run temptation to cheat is greater than long run benefit of cooperating.

what is tacit collusion?

firms coordinate behaviour without communication, this is achieved by repeated play and observing past actions.

why does collusion fail in a in finite horizon?

• no punishment possible in last period, firms cheat and this unravels backwards.

why is collusion sustained in infinite horizon?

• always credible punishment due to no end date.

• fear of losing future profits.

what occurs under the Grim Trigger Strategy?

• cooperate until someone cheats, then punish forever with Nash Equilibrium.

• collusion holds if future loss from punishment exceeds the short run gain from cheating.

• threat of punishment disciplines firms.

what occurs in Bertrand collusion?

• firms choose prices.

• firm undercuts/deviates by 1p, it captures the entire market. the temptation to deviate is enormous.

• harshest punishment possible.

• as the number of firms increases, the temptation to deviate increases.

• firms need to be very patient (high discount factor) to resist the huge temptation to undercut.

what occurs in Cournot collusion?

• firms choose output, they deviate by restricting output.

• deviating only gets a moderate gain.

• when punishment occurs, nash profits are positive and so the punishment is weaker.

• less patience needed as deviation gains are smaller.

what is the optimal punishment mechanism in Cournot?

Cournot Grim trigger punishment is no strong enough as profits still remain >0, therefore impatient firms still deviate.

NEED FOR…

CARROT AND STICK.

• one period of extremely harsh punishment.

• Return to collusion immediately after.

• punishment is finite, firms know that cooperation resumes quickly if they behave.

• punishment must be credible so that they don’t just continue to deviate.

• Firms punish because it doesn’t last forever and it isn’t too costly.

• makes collusion stable even when firms are impatient.

what two constraints need to be met in the CARROT AND STICK MECHANISM?

credibility - ensures the punishing firm actually wants to carry it out. punishing must be better than deviating during the punishment phase. they know that they will return to collusive profits afterwards.

sustainability -

ensures the deviating firm doesn’t want to cheat in the first place.

the discounted loss of punishment outweights the one-period gain from cheating.