Economics of Regulation and Antitrust

Collusion

Oligopoly
A. Few Sellers / Recognized

Interdependence
B. Cournot Model

Firms choose quantity Assume that other firm does change output Example compared to PC and Monopoly

Oligopoly - Bertrand Model

Firms choose price rather than output. With identical goods and constant MC, then P=? If products are differentiated. - Example

Oligopoly - Chamberlin (Monopolistic Competition)

Criticized Bertrand and Cournot models because they failed to recognize their interdependence. He argued that intelligent managers would know where the profitmaximizing price is and would be reluctant to reduce price and leave all members of the industry worse off.

Oligopoly - Stackelberg Model Price Leadership

Designate one firm as a dominant firm and all the other's in the industry follow this firm's cues. I.e. one firm announce price changes and all the others follow. Examples
Automotive industry Banking Industry

Oligopoly - Stigler's Theory

Incentive to collude is strong so as to

maximize joint profits but so is the incentive to cheat. If any member can secretly violate the agreement, he will gain larger profits than by conforming to it. Therefore enforcement, i.e. detecting significant deviations from the agreedupon prices, is paramount

Stigler example
Suppose 3 identical firms with zero costs ,

facing a market demand curve of Q=180-5P. The monopoly price and quantity is $18 and 90 and the three firms agree to each supply 30. The $1620 industry profits are split $540 to each.

Oligopoly

Oligopoly

d is the demand curve when everyone knows (everyone makes 533.33), d' is when there are secret cuts(if offered to all his customers then $640, if only to "new" customers - $700), d'' is secret cut that steals away other firms customers without the other firm reacting - $800). Conclusion - there is a great temptation to secretly cut prices. Key is detection and response.

Oligopoly - Game Theory

Prisoner's Dilemma - Two suspected criminals

Butch and Sundance are arrested and put in separate cells unable to communicate. If one confesses while the other does not, the one who confesses is granted immunity and goes free and the other goes to jail for 20 years. If both confess they both go to jail for 5 years. If both are silent, both go to jail for only one year, for a lesser crime (concealed weapons). The payoff matrix looks like this:

Oligopoly

Butch Confesses Remains Silent

Sundance Confesses (-5,-5) (-20,0) Remains Silent (0,-20) (-1,-1)

Whatever Butch does, Sundance is better off confessing. Whatever Sundance does, Butch is better off confessing. Both they are both better off if they both remain silent. How can this be?

Oligopoly
Duopolist's Dilemma
Firm A

Firm B

Cut Price ($12) Fix Price ($18) ($1440,0) ($810,$810)

Cut Price ($12) ($720,$720) Fix Price ($18) (0,$1440)

Dominant Strategy is to cut price but both firms are better off by fixing prices.

Can Collusion be beneficial?

It reduces uncertainty in profit rate , demand uncertainty in the face of production indivisibilities Example

Can Collusion be beneficial?

Indivisibilities in production. Other problems - large fixed and some avoidable costs with uncertain demand.

Public Policy toward Oligopoly and Collusion

Section 1 of Sherman Act declares every

contract, combination, or conspiracy in restraint of trade illegal. Price-fixing and related practices were judged illegal per se i.e. in and of themselves. There is to asking of whether there were extenuating circumstances no test of reasonableness

Cases
Addyston Pipe and Steel Trenton Potteries Socony-Vacuum Interstate Circuit American Tobacco