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Unformatted text preview: Collusion So be deviating Firm 1’s profits are: V = π M So for the proposed strategies to form an equilibrium it has to be the case that 1 2 π M 1 1 δ ≥ π M which is equivalent to δ > 1 2 So the question then becomes what determines δ ? It is directly related to the interest rate, or the rate of return on some low risk asset. If the interest rate is r , $ 1 today is worth $(1+r) in the next period, so δ = 1 1 + r Collusion There are other factors that also determine the discount rate. As we’ll see these factors will help explain why some industries engage in price wars, or other forms of noncollusive behavior. One such factor is the frequency at which firms changes their prices. So if r denotes the annual interest rate and f denotes the frequency of price changes per year. Then we have δ = 1 1 + r / f Another important factor is the probability any payment will be received in the future. Collusion This will be of concern if a third firm enters the industry in the future and can produce at lower costs. We’ll denote this by h , the probability that the industry exists in the future, with h ≤ 1. Still taking into account the frequency of meetings, we compute the discount factor as: δ = 1 1 + r / f h Another factor to be taken into account is the growth rate of the industry....
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 Fall '08
 ShakeebKhan
 Marketing, Pricing, Oligopoly, Collusion

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