B2.01.15: Collusion (Game Theory)

Question 1

Define collusion (firms that behave like how monopolies would)

Answer 1

An agreement to fix prices such as
- holding prices constant at some level
- raising prices by some fixed amount
- fixing price differences between products

Therefore limiting competition

Question 2

Define overt collusion

Answer 2

Firms get together and decide to fix prices and quantities

Question 3

Define Tacit Collusion

Answer 3

Informal agreements to not agree in price wars

Question 4

Define price leadership collusion

Answer 4

A dominant firm in that company sets prices and smaller firms follow those pricing decisions

Question 5

State 6 factors promoting collusive oligopolies

Answer 5

• Small number of firms (more concentrated oligopoly)
• Similar costs
• High barriers to entry
• Ineffective competition policy
• Consumer loyalty
• consumer Inertia

Question 6

Explain how small number of firms (more concentrated oligopoly) promote collusive oligopolies

Answer 6

much easier to organise collusive agreements

Question 7

Explain how similar costs promote collusive oligopolies

Answer 7

Easy to organise fixed costs and quantities to produce at as they are more likely to agree on prices or quantities

Question 8

Explain how high barriers to entry promote collusive oligopolies

Answer 8

Supernormal profits made will not attract new entry into the market as the high barriers to entry can stop this from happening thus, benefits of collusion can last for the long term

Question 9

Explain how ineffective competition policy promote collusive oligopolies

Answer 9

Then by colluding, firms are aware that they are likely to get away with it

Question 10

Explain how consumer loyalty promote collusive oligopolies

Answer 10

If firms decide to cheat rivals by undercutting them on price, it will not be beneficial to that firm if consumers are loyal to those rivals

Question 11

Explain how consumer inertia promote collusive oligopolies

Answer 11

onsumers may not want to switch to another supplier or there may be barriers to switching. If a firm cheats on a collusive agreement, there is no guarantee that lots of consumers will come to them and buy their products instead

Question 12

Performance evaluation of collusive oligopoly (firms that behave like how monopolies would)

Answer 12

Talk about Monopolies and on a diagram:

• Cons: Monopolies can’t achieve allocative and productive efficiency, there is Diseconomies of Scale.
• Pros: Benefits like Dynamic Efficiency and EOS benefits too

Question 13

What is a cartel

Answer 13

A formal agreement between firms in an industry to take actions to limit competition in order to increase market power of firms and, ultimately, increase profits

Question 14

What is the prisoner’s dilemma

Answer 14

• 2 individuals acting in their self-interest resulting in them not producing at the optimal outcome for both

Question 15

What is a Nash Equilibrium

Answer 15

Pricing strats that can last in the long run

Question 16

What is the price rigidity conclusion that can be drawn from Game Theory (Collusion)

Answer 16

Price rigidity: If the Nash Equilibrium’s reached, it makes no sense for price to change further hence, if firms are going to compete, they’re going to compete on non-price factors

Question 17

What is the temptation to collude conclusion that can be drawn from Game Theory (Collusion)

Answer 17

Temptation to collude: The Nash Equilibrium is not the best outcome for both firms combined hence, if interdependence is broken and both firms settle on a price, they both can be making supernormal profits and get to outcomes that are, joint, of best interest to firms

Question 18

What is the incentive to cheat conclusion that can be drawn from Game Theory (Collusion)

Answer 18

Incentive to cheat on the collusive agreement:
even if there’s a collusive agreement, the other firm will always have the incentive to cheat on it and try go for greater profits therefore, collusion may not last in the long run as both firms will end up back at the revenue maximisation point

Question 19

State 5 factors promoting competitive oligopolies

Answer 19

• Large number of firms (less concentrated oligopoly)
• New market entry possible
• One firms with significant cost advantage
• Homogenous goods
• Saturated market

Question 20

Explain how large number of firms promote competitive oligopolies

Answer 20

organising collusion with lots of firms is much more difficult

Question 21

Explain how new market entry possible promote competitive oligopolies

Answer 21

making lots of supernormal profits by colluding together is not attractive as it will incentivise new firms to enter the market and take those supernormal profits away

Question 22

Explain how one firm with significant cost advantages promote competitive oligopolies

Answer 22

makes it difficult to organise a fixed a price or quantity to produce at in collusion

Question 23

Explain how homogenous goods promote competitive oligopolies

Answer 23

firms dont have the price making power to fix prices

Question 24

Explain a saturated market promotes competitive oligopolies

Answer 24

Lots of price wars and price competition thus, there will be incentives to cheat on collusive agreements is strong given the incentives of taking market share

Question 25

Performance evaluation of competitive oligopoly

Answer 25

• Pros: Allocative & productive efficiency
• Cons: EOS benefits lost, Dynamic efficiency is lost