Game theory

• What is Collusive behavior?

  Occurs when rival firms agree to work together to make higher profits at the expense of consumers and reduces the competitiveness of the market.
• Types of Collusion

  • Overt Collusion
  • Tacit Collusion
  • Price Leadership
• What is overt collusion?

  When firms make formal agreement to stick to high prices. This can involve the creation of a cartel.
• What is tacit collusion?

  Where firms make informal agreements or collude without actually speaking to their rivals. This may be to avoid detection by government regulators.
• What is price leadership collusion?

  Possibility that firms may try to unofficially collude by following the prices set by a  market leader. This enables them to keep prices high, without ever meeting with rival firms.
• Problems of collusion

  Collusion can lead to:

  • High prices for consumers. This leads to a decline in consumer surplus and allocative inefficiency (Price pushed up above marginal cost)
  • New firms can be discouraged from entering the market by types of collusion which act as a barrier to entry.
  • Easy profits from collusion can make firms lazy and avoid innovation and efforts to increase productivity.
  • Industry gets the disadvantages of monopoly (higher price) but none of the advantages (e.g. economies of scale)
• Collusion usually involves some form of agreement to seek higher prices. This may involve:

  • Agreeing to increase prices faced by consumers.
  • Deals between suppliers and retailers.
  • Monopsony pricing
  • Collusion between existing firms in an industry to exclude new firms from deals to prevent the market from becoming more competitive.
  • Sticking to output quotas and higher prices.
  • Collusive tendering.
• What is collusive tendering?

  when a rival firm agrees to set artificially high price to allow the firm of choice to win with a relatively high contract offer.
• What is monopsony pricing?

  where retailers collude to reduce the amount paid to suppliers.
• What is a cartel?

  a formal type of collusion
• Cartels aim to:

  • Increase price
  • Distort normal workings of a competitive market
  • Redistribute income in society from consumers to powerful vested interests.
  • Successful cartels become an ‘easy’ way to make profit, therefore it may discourage innovation and efficiency gains.
• Whats an example of a cartel?

  OPEC
• What is Game theory?

  is the study of strategic interaction where one player’s decision depends on what the other player does. What the opponent does also depends upon what he thinks the first player will do.
• What is dominant strategy?

  when one choice gives better result than other
• What is Nash Equilibrium?

  where each player has nothing to gain by changing strategy, given the choices of the other player. 
• Game Theory Examples

  • Price Wars
  • Zero-Sum Game
  • Prisoner's dilemma
• Price Wars Diagram

  Best Outcome is a.

  However, if one firm cuts prices (starts price war) it will see profits rise to 60. But the other will lose market share and get 0 profits.

  Therefore, the firm who loses out will retaliate and the outcome will move to d.

  Therefore strong incentive to avoid price war.

  A) Firm B

  B) Firm A

  C) Stable Prices

  D) Price War

  E) Stable Prices

  F) Price War

  
• Zero-Sum Game diagram

  If a firm enters or leaves, there is always a net benefit of zero.

  For Firm A, its dominant strategy is to enter the market, because 1 is greater than -2.

  For firm B, its dominant strategy is also to enter the market because -1 is greater than -3.

  Firm B would prefer both firms to leave the market so it can get to zero.

  But, in this model, it can’t do that because it know if A enters, it will have to enter or face the costs of -3.

  A) Firm B

  B) Firm A

  C) Enter Market

  D) Leave Market

  E) Enter Market

  F) Leave Market

  
• What is a zero-sum game?

  a situation where one party benefits at the equal cost of another. If we add gains and losses the net benefit will always be zero.
• Collusion Diagram

  The aim is to charge a high cartel price and maximise joint profits for cartel members.

  A) Cartel Price

  B) Cartel Price

  C) MC

  D) Industry Supply

  E) AC

  F) Industry AR

  G) MR

  H) Cartel Output

  I) Output Quota

  J) Cartel Member

  K) MC

  L) AC

  M) Industry