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- Horizontal – Arrangements involving firms at the same level of the supply chain, i.e. firms that are competitors.
- Vertical – Arrangements between firms at different levels of the supply chain, e.g. between manufacturers and distributors.
'People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.'
Adam Smith The Wealth of Nations
- Small number of firms
- Mutual Recognition of Interdependence Key Characteristics of Oligopolistic Markets.
- Filling Station Example.
- Recognition of interdependence removes incentive to compete
- Strong incentive to collude
- In oligopoly non-competitive outcome possible without actual collusion.
Study of pricing behaviour of UK firms indicated that a significant proportion were reluctant to cut prices for fear of triggering a price war.
Hall, Walsh and Yates (1996): How do UK Companies Set Prices, Bank of England, Quarterly Bulletin (May).
Chamberlin argued that, if firms recognised their mutual interest in high prices, then price would tend to be set at the monopoly level, since this would maximise industry profits.
Chamberlin, E.H., (1933): The Theory of Monopolistic Competition.
- Pepsi/Coca Cola
- Competition on price was
- 'precisely the kind of competition both companies wanted to avoid.'
- Entry of own labels in 1990s triggered price cuts
- Once own labels exited price competition ceased
- Martin, Back to Business as Usual, Financial Times, 4.4.1996.
- Firms' expectations regarding rivals' behaviour key to determining the outcome in oligopolistic markets.
- Focus on attempting to explain how firms' expectations are formed and how they interact with one another largely based on 'Game Theory'.
- Game theory 'a collection of tools for predicting outcomes for a group of interacting agents, where an action of a single agent directly affects the payoffs (welfare or profits) of other participating agents.'
- Firms in oligopolistic similar to players in a game. Individual firm will attempt to choose a strategy which maximises its payoff or profit.
- Each firm is aware that its profits depend on rivals' strategies.
- Stable solution to such games arises when no player has an incentive to alter their strategy.
- Such a solution is called a Nash equilibrium, after Nobel laureate, John Nash, the pioneer of game theory, whose story was told in the film A Beautiful Mind.
- Describes position facing two suspects - Shane and Ciara - arrested by the police for, say armed robbery.
- Each questioned separately.
- Each of them knows the following:
- If neither confesses police will only be able to secure a conviction on a lesser charge of possession of stolen goods, with light sentence – 12 months
- If they confess, turn State's evidence and their accomplice does not, they can avoid a custodial sentence, while accomplice will receive a sentence of ten years.
- If they do not confess and accomplice does, they will receive a sentence of ten years.
- If both confess, both receive a sentence of six years.
|
Shane's
Options |
|
Ciara's
Options |
|
|
Don't
Confess |
Confess |
||
|
Don't
Confess |
1
1 |
10
0 |
|
|
Confess |
0
10 |
6
6 |
|
- Two firms Priceright and Bestvalue producing similar products.
- Both must choose between charging a high price or price cutting, i.e. between competing or not competing.
- Profits accruing to each firm depending on the pricing strategies pursued by each of them.
|
Priceright's
Options |
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Bestvalue's
Options |
|
|
€10 |
€5 |
||
|
€10 |
€500k
€500k |
€100k
€1m |
|
|
€5 |
€1m €100k
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€300k
€300k |
|
- Prisoners' dilemma a one-shot game.
- Firms compete repeatedly over time.
- Repeated game where they must continually choose between high price or low price strategy.
- Each time firms make their decisions they know how rival behaved on previous occasion.
- Where the game is played on a finite number of occasions cooperative outcome will not emerge. Working backwards, in the last round of the game, the parties are in the same situation as in the one-off game and so both opt to compete.
- Low price (competing) strategy is best option in penultimate period and so on.
- The outcome of infinitely repeated game depends to a significant degree on the discount factor that firms apply to future profits, i.e. what is the value of higher future profits relative to higher profits today.
- Under certain conditions cooperative outcomes which are not equilibria in a one shot game, can emerge as an equilibrium outcome in an infinitely repeated non-cooperative game.
- As long as each firm charges €10 they both earn €500,000 p.a.
- Each knows that if it cuts price and the other does not it will double its profits to €1m in the current year.
- Each also knows that if it cuts price, rival is likely to adopt a price cutting strategy in the future - in subsequent years both charge €5 and make €300,000 p.a.
- Benefit of cutting price in one period is to gain €500,000 that year, but will earn €200,000 p.a. less thereafter.
- Whether the firms maintain high or low prices will depend on how they value higher profits continuing into the future against a short-term gain in the present.
Challenge facing oligopolists is to devise a way of overcoming the 'prisoners' dilemma' in repeated game.
Competition law attempts to prevent firms doing so.
Collusion may be either overt or tacit - tacit collusion poses a number of difficulties for competition law.
If discount factor is sufficiently high - cooperative outcome is only one of several possible outcomes that may emerge as a result of an infinitely repeated non-cooperative game.
Phlips (1995) - impossible to correctly identify tacit collusion because a cooperative outcome may be the result of non-cooperative behaviour by competing oligopolists.
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