ECOS2201-prelect07 - S I D E R E M E N S E A D E M M U T A...

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Unformatted text preview: S I D E R E M E N S E A D E M M U T A T O University of Sydney ECOS2201 - Lecture 7 1 Cooperation We concentrate on Tacit cooperation where there is no explicit agreement between firms, but rather an implicit understanding Cooperation between firms is often anti-competitive and so illegal, this makes explicit cooperation a dangerous strategy 2 Shared Interest A shared interest provides the basis for cooperation. The tobacco industry has a shared interest in convincing customers that smoking is not dangerous, two competitors have a shared interest in setting higher prices. 3 For cooperation to succeed it is essential that all parties share in the benefits of cooperation. Why cooperate if get nothing in return. 4 Consider the following example. Let industry demand be p = 100- Q. There are two firms, 1 and 2 that choose outputs, where q 1 + q 2 = Q. Both firms have the same constant marginal cost, c = 10 The best response functions are q 1 = 45- 1 2 q 2 and q 2 = 45- 1 2 q 1 . The nash equilibrium outputs are q n i = 30 = q n 2 . The equilibrium price is 40 and the profits are n 1 = 900 = n 2 . 5 The monopoly solution is Q m = 45 with price 55. Assume each firms produces half of this so that q m 1 = 22 . 5 = q m 2 . Profits of each firm are m 1 = 1012 . 5 = m 2 . Note, there is a shared interest as total profit is greater than under noncooperative (nash) equilibrium. Also note, the gains from cooperation have been shared equally. 6 If firm 1 produces q m 1 = 22 . 5 the best response of firm 2 is not 22.5 but rather q cheat 2 = 33 . 75. With these outputs the price is 43.75 and each firms profits are cheat 1 = 759 and cheat 2 = 1139 > 1012 . Therefore, firm 2 has an incentive to cheat on the agreement. This is the basic problem of cooperation. How to stop cheating 7 But in real world games are played more than once, what if this game is repeated eg. every week, every month....
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ECOS2201-prelect07 - S I D E R E M E N S E A D E M M U T A...

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