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Unformatted text preview: Industrial Organization: EC460 Spring 2009 Instructor: Thomas D. Jeitschko Some Class Notes on Collusion in Oligopoly Recall that when we first began to study oligopoly, we considered the following scenario: Two firms (a duopoly) supply a market represented by demand of P = 20 Q , where Q = Q 1 + Q 2 . That is, the market price will be determined as the price that clears the market, given the output of the two firms. Both firms have costs of C i = ( Q i ) 2 , where i can be 1 or 2. In our first analysis of this setting, we reduced the model to a payoff matrix in which we considered the strategies of firms producing either 3 or 4 units independently. We obtained: Q 2 = 3 Q 2 = 4 Q 1 = 3 33 , 33 30 , 36 * Q 1 = 4 36 * , 30 32 * , 32 * Table 1: Payoff Matrix for output combination involving 3 and 4 units In this payoff matrix, we have placed an asterisk (*) next to the optimal (profit maximizing) choices conditional on the rival’s choice of output. Despite the joint profit being the lowest when both firms produce 4 units, this is actually the unique outcome for the firms, as it is a dominant strategy to produce 4 units—your profits are always higher when producing 4 units, regardle3ss of what the rival firm does. We briefly contemplated other outcomes, but in addition to noting the logic of the dominant strategy argument, we also noted that firms colluding—each agreeing to produce only 3 units—is generally illegal anticompetitive behavior in the U.S. To see why, we expand the payoff matrix to include consumer surplus, which allows us to calculate total welfare for the four possible outcomes under consideration....
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 Spring '08
 Boyer
 Game Theory, Oligopoly, partner, Dominant strategy, payoff matrix, collusive agreement

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