No One
Chapter 5: Cartels (Collusion)
Why Cartels Form
Cartels are formed to increase individual profit for the firm. This is accomplished by using the monopoly strategy of decreasing output and increasing price. However, there is a free rider problem that can be overcome with a cartel. Any individual firm can decrease output independently in an oligopoly and see prices and profits increase for all firms in the industry – with the larger gains going to the firms that did not change their output.
A cartel therefore becomes 1. An enforcement mechanism to overcome free-riding 2. An enforcement mechanism to punish cheating 3. An agency to determine output levels, and 4. An agency to divide the gains of the cartel.
Difficulties: 1. Coordinating collusion is a problem, despite the fact that is maximizes industry profit 2. Overt or explicit collusion is illegal in the U.S. 3. Most efforts to fix prices are tacit (conscious parallelism) 4. The trick is to influence rivals behavior by signaling and threatening to punish defection 5. Need cooperation-inducing strategy as a “focal point” – a strategy so compelling that a firm would expect all other firms to adopt it
Need repeated competition over a number of periods to establish a focal point or reputation.
The development of repeated, multi-period games in Game Theory was an important development for IO, allowing for more complex and realistic interactions between firms.
Why is cooperation so difficult for finite games (where the last period is known for certain)?
Factors Necessary to Establish a Cartel
1. Must be able to raise price w/o inducing competition from outside the cartel
2. Expected punishment for forming the cartel must be low relative to the gains (Note: most cartels are international)
3. Cost for establishing and enforcing the cartel must be less than the gains
Facilitating Practices for Cooperative Pricing: 1. Price leadership
Why Cartels Form
Cartels are formed to increase individual profit for the firm. This is accomplished by using the monopoly strategy of decreasing output and increasing price. However, there is a free rider problem that can be overcome with a cartel. Any individual firm can decrease output independently in an oligopoly and see prices and profits increase for all firms in the industry – with the larger gains going to the firms that did not change their output.
A cartel therefore becomes 1. An enforcement mechanism to overcome free-riding 2. An enforcement mechanism to punish cheating 3. An agency to determine output levels, and 4. An agency to divide the gains of the cartel.
Difficulties: 1. Coordinating collusion is a problem, despite the fact that is maximizes industry profit 2. Overt or explicit collusion is illegal in the U.S. 3. Most efforts to fix prices are tacit (conscious parallelism) 4. The trick is to influence rivals behavior by signaling and threatening to punish defection 5. Need cooperation-inducing strategy as a “focal point” – a strategy so compelling that a firm would expect all other firms to adopt it
Need repeated competition over a number of periods to establish a focal point or reputation.
The development of repeated, multi-period games in Game Theory was an important development for IO, allowing for more complex and realistic interactions between firms.
Why is cooperation so difficult for finite games (where the last period is known for certain)?
Factors Necessary to Establish a Cartel
1. Must be able to raise price w/o inducing competition from outside the cartel
2. Expected punishment for forming the cartel must be low relative to the gains (Note: most cartels are international)
3. Cost for establishing and enforcing the cartel must be less than the gains
Facilitating Practices for Cooperative Pricing: 1. Price leadership