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Economics of Markets and Organizations (Subject) / Repeated Interaction (Lesson)
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- Trigger Strategy 𝛱𝐶 : Cooperative payoff 𝛱𝐷 : Deviation payoff 𝛱𝑁 : One-shot Nash payoff 𝛿 ≥ (𝛱𝐷 − 𝛱𝐶) / (𝛱𝐷 − 𝛱𝑁)
- Discount factor 𝛿 = 1/(1+𝑟) low = future is less worth high= future is more worth
- Net present value from cooperating in all periods = 𝛱𝐶 / (1−𝛿)
- Net present value from deviating =𝛱𝐷 +𝛿*𝛱𝑁 / ( 1−𝛿 )
- Trigger strategy stability condition 𝛱𝐶 / (1−𝛿) ≥ 𝛱𝐷 + 𝛿𝛱𝑁 / (1−𝛿) = 𝛿 ≥ (𝛱𝐷 − 𝛱𝐶) / (𝛱𝐷 − 𝛱𝑁)
- Analyzing the stability condition Cooperation is (only) feasible if the discount factor exceeds the critical discount factor 𝛿 = (𝛱𝐷 − 𝛱𝐶) / (𝛱𝐷 − 𝛱𝑁) 𝛿 is decreasing in 𝛱𝐶 𝛿 is increasing in 𝛱𝑁 and 𝛱𝐷
- (Tacit) collusion in markets Collusion Independent firms take joint decisions Tacit collusion Independent firms take independent decisions that have the same consequences as in the situation in which the decisions would have been taken jointly Oligopolistic firms have a strong incentive to collude Oligopoly profits are lower than the monopoly profit
- Why don’t firms collude all the time? Cartels are illegal Incentives to devaite from an cullusive agreement too low discount factor sector specific factors
- Sector specific factors - Market concentration The fewer firms in the market... ... the easier it is to coordinate behavior (“what is the collusive price?”) ... the bigger the collusive profits (𝛱𝐶) compared to the oligopoly profits (𝛱𝑁) and the deviation profits (𝛱𝐷) Market concentration facilitates (tacit) collusion
- Sector specific factors - High entry barriers The lower entry barriers... ... the more difficult it is to generate above normal profits because of the entry those will provoke (‘hit and run’ profits) ... the more future entry decreases future collusive profits (lower 𝛱𝐶) Entry barriers facilitate (tacit) collusion
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- Sector specific factors - Transparency The more transparent the market... the easier it is to determine the price on which to coordinate the better a firm is able to explain why demand is low the faster it can react to another cartel member deviating the shorter is a period the higher the discount factor (𝛿) Transparency facilitates (tacit) collusion
- Sector specific factors - frequent interaction The more often firms interact... the sooner the “next period” will start the higher the discount factor
- Sector specific factors - stable demand The more stable demand... the easier it is to observe deviations by competitors the better a firm can react to another cartel member deviating Unstable demand: is it attractive to deviate if demand is high is it unattractive to deviate if demand is low cartel stability cannot be enforced by always punishing in the case of low sales cartel stability cannot be enforced by never punishing in the case of low sales cartel stability can be enforced by punishing temporarily
- Sector specific factors - symmetric firms The smaller the cost differences between firms... the easier it is to coordinate behavior (“what is the collusive price?”) the less the most efficient firm can win by deviating (lower 𝛱𝐷) the easier the most efficient firm can be punished by other cartel members (lower 𝛱𝑁) The greater the differences in production capacity ... the more attractive deviation becomes for the firm with the largest production capacity the more difficult punishment becomes for firms with low production capacity (higher 𝛱𝑁) The greater the differences in the number of product lines ... the more interesting it becomes for a firm with a few product lines to deviate (higher 𝛱𝐷) the more costly it becomes for firms with many product lines to ‘punish’ (𝛱𝑁 increases) The more horizontally differentiated products are ... the smaller the deviation profits 𝛱𝐷 (a decrease in price results in fewer additional consumers) the greater the oligopoly profits (the firms become local monopolists to a greater extent) so that deviations can be punished less severely (higher 𝛱𝑁)
- Facilitating Practices Mergers increases market concentration which facilitates (tacit) collusion Lowest price guarantee makes the market more transparent which facilitates (tacit) collusion most favoured customer clauses means that today’s customer pays a lower price if the price decreases in the near future decrease deviation profits (lower 𝛱𝐷)