Cartels:Collusion

Class 8

Ref: Collusion: The Great Prisoners’ Dilemma.Collusion: The Great Prisoners’ Dilemma. Chapter 8. Industrial Organization – Theory & Practice. Second Edition. Waldman – Jensen. Addison Wesley. pp. 228–252

Industrial Economics

Flavio Pinto

Contents

The Prisoners’ Dilemma Revisited Tit for tat Present Value and Discounting Trigger Price Strategy Collusive Agreements

Contents

The Prisoners Dilemma

The Prisoners Dilemma

The Game

80,80120, 25

25,120100,100General Electric

Collude

Defect

Westing House

Collude Defect

Tit for Tat Strategy

The Prisoners Dilemma

80,80120, 25

25,120100,100

GECollude

Defect

WHCollude Defect

Start the first round cooperating In every subsequent round, adopt your opponent’s

action in the previous round.

RoundRound GE GE (Act-Payoff)(Act-Payoff)

WH WH (Act-Payoff)(Act-Payoff)

1 Collude (25) Defect (80)

2 Defect (80) Defect (80)

3 Defect (80) Collude(25)

… Collude ( ) …

Tit for Tat vs. Dominant Strategy

Tit for Tat

RoundRound GE GE (Tit for Tat)(Tit for Tat)

WH WH (Dominant (Dominant Strategy)Strategy)

1 Collude (25) Defect (80)

2 Defect (80) Defect (80)

3 Defect (80) Defect (80)

… … …

200 Defect (80) Defect (80)

Tot. Profit GE: 15,945 16,040

Tit for Tat vs. Tit for Tat

Tit for Tat

RoundRound GE GE (Tit for Tat)(Tit for Tat)

WH WH (Tit for Tat)(Tit for Tat)

1 Collude (100) Collude (100)

2 Collude (100) Collude (100)

3 Collude (100) Collude (100)

… … …

200 Collude (100) Collude (100)

Tot. Profit GE: 20,000 20,000

Dominant vs. Dominant

In Tit for Tat context…

RoundRound GE GE (Tit for Tat)(Tit for Tat)

WH WH (Tit for Tat)(Tit for Tat)

1 Defect (80) Defect (80)

2 Defect (80) Defect (80)

3 Defect (80) Defect (80)

… … …

200 Defect (80) Defect (80)

Tot. Profit GE: 16,000 16,000

Tit for Tat with Uncertainty

In Tit for Tat context…

RoundRound GE (Tit for Tat)GE (Tit for Tat) WH (Tit for Tat)WH (Tit for Tat)

1 Collude (100) Collude (100)

2 Collude (100) Collude (100)

3 Nature: defect (120) Collude (25)

4 Collude (25) Defect (120)

5 Collude (100) Collude (25)

6 Defect (120) Defect (120)

7 Collude (25) Collude (25)

8 Defect (80) Defect (120)

9 Defect (80) Nature: defect (80)

10 Defect (80) Defect (80)

11 Defect (80) Defect (80)

… … …

200 Defect (80) Defect (80)

Tot. Profit GE: 15,995 15,995

Tit for Tat Nice with Uncertainty

In Tit for Tat context…

RoundRound GE (Tit for Tat)GE (Tit for Tat) WH (Tit for Tat)WH (Tit for Tat)

1 Collude (100) Collude (100)

2 Collude (100) Collude (100)

3 Nature: defect (120) Collude (25)

4 Collude (100) Collude (100)

5 Collude (100) Collude (100)

6 Collude (100) Collude (100)

7 Collude (100) Collude (100)

8 Collude (100) Collude (100)

9 Collude (25) Nature: defect (80)

10 Collude (100) Collude (100)

11 Collude (100) Collude (100)

… … …

200 Collude (100) Collude (100)

Tot. Profit GE: 19,945 19,945

Trigger Price Strategy

Trigger Strategy

Start the first round cooperating and charging the joint-profit maximizing price P= 55.

Continue to charge the joint-profit maximizing price P = 55 unless the other player lowers price below P = 55, in which case charge the Equilibrium price P = 10 forever

Net Present Value

Trigger Strategy

The Concept

Net Present Value

Trigger Strategy

The Formula

Collusive Agreement as Viewed By One Firm Cartel

Collusion

$

Q

Factors Affecting Collusion

Number of Firms Concentration Rate of Technological Change Demand Growth and Elasticity Frequency of Sales

Factors

Practical Problems

Please, solve problems 1, 2, 3 and 4 (pp. 249-250)

Exercises