Competition and Markets lecture 3- collusion and cartels

what are the two processes of cartel formation?

• Sequential formation of cartels: each firm sequentially decides whether or not to join the cartel or to stay in competition. For this to work firms need to be able to commit themselves to participation. 1 firm proposes a cartel if all members accpet then a cartel is formed. Otherwise first firm that refuses proposes another cartel

• Simultaneous formation of cartels: firms decide simultaneously whether they would like to be in the cartel.

Firms decide to stay in the industry when, also what positive externalities arise on firms outside the cartel:

πin > πout or a-c²/ k(n-k+2)²> a-c²/(n-k+3)²

This is assuming cartel profits are split equally

Formation of a cartel induces positive externalities on firms outside the cartel, this being a higher Market price

Grim trigger strategy for cartel formation:

when co operating πc=πm/2

when one firm deviates πd where deviation profit is almost equal to monopoly profit, eventually results in πn

with πd>πc>πn

Present Discounted value for co- operative phase = 1/1-δ* πc

Whether firms deviate depends on the trade off between the immediate gain of πd and the future losses of πn.

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