ch7 - Industrial Organization Chapter 7 1 Chapter 7...

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Unformatted text preview: Industrial Organization: Chapter 7 1 Chapter 7 Collusion and Cartels Industrial Organization: Chapter 7 2 Collusion and Cartels • What is a cartel? – attempt to enforce market discipline and reduce competition between a group of suppliers – cartel members agree to coordinate their actions • prices • market shares • exclusive territories – prevent excessive competition between the cartel members Industrial Organization: Chapter 7 3 Collusion and Cartels • Cartels have always been with us – electrical conspiracy of the 1950s – garbage disposal in New York – Archer, Daniels, Midland – the vitamin conspiracy • Some are explicit and difficult to prevent – OPEC – De Beers – shipping conferences Industrial Organization: Chapter 7 4 Collusion and Cartels • Other less explicit attempts to control competition – formation of producer associations – publication of price sheets – peer pressure (NASDAQ?) – violence • Cartel laws make cartels illegal in the US and Europe • Authorities continually search for cartels • Have been successful in recent years – Nearly $1 billion in fines in 1999 Industrial Organization: Chapter 7 5 Collusion and Cartels • What constrains cartel formation? – they are generally illegal • per se violation of anti-trust law in US • substantial penalties if prosecuted – cannot be enforced by legally binding contracts – the cartel has to be covert • enforced by non-legally binding threats or self-interest – cartels tend to be unstable • there is an incentive to cheat on the cartel agreement – MC > MR for each member – cartel members have the incentive to increase output – OPEC until very recently Industrial Organization: Chapter 7 6 The Incentive to Collude • Is there a real incentive to belong to a cartel? • Is cheating so endemic that cartels fail? • If so, why worry about cartels? • Simple reason – without cartel laws legally enforceable contracts could be written by cartel members • De Beers is tacitly supported by the South African government • gives force to the threats that support this cartel – not to supply any company that deviates from the cartel • Without contracts the temptation to cheat can be strong Industrial Organization: Chapter 7 7 The Incentive to Cheat • Take a simple example – two identical Cournot firms making identical products – for each firm MC = $30 – market demand is P = 150 – Q where Q is in thousands – Q = q 1 + q 2 Price Quantity 150 150 Demand 30 MC Industrial Organization: Chapter 7 8 The Incentive to Cheat Profit for firm 1 is: π 1 = q 1 (P - c) = q 1 (150 - q 1- q 2- 30) = q 1 (120 - q 1- q 2 ) To maximize, differentiate with respect to q 1 : ∂π 1 / ∂ q 1 = 120 - 2q 1- q 2 = 0 Solve this for q 1 q* 1 = 60 - q 2 /2 This is the best response function for firm 1 The best response function for firm 2 is then: q* 2 = 60 - q 1 /2 Industrial Organization: Chapter 7 9 The Incentive to Cheat These best response functions are easily illustrated...
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ch7 - Industrial Organization Chapter 7 1 Chapter 7...

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