IO4 - Competition Policy

• 2 firms making identical products. MC=30. P=150-Q.
• The BR functions for firms 1 and 2 are: 
• -
• -
• Sub q2 into BR1
• -
• -
• Solve for q1*, q2*, P* and profits.
• -
• -
• Under collusion the firms act as a monopoly. MR=MC
• -
• -
• -
• -
• Greater profit under collusion that in the cournot equilbrium. 

• Firms know when the game is going to end. Example, game is repeated twice
• First game: co-operate .
• Second: if the opponent deviates there is no third stage to punish them in. SO they will deviate and so will you. 
• We know both players are cheating in the second stage so the first play is the last unknown play. Therefore the same logic - both firms will cheat. 
• Subgame Perfect Nash Equilibrium: non-cooperative behaviour in both stages.  
• Seltens Theory: Finitely repeated play of a unique Nash equilibrium is the same of the repeated game. 

Example

• 2 indentical firms. MC=30. P=150-Q
• Value profit streams:
• -
• -
• Profit from co-operating
• -
• -
• Profit from deviating
• -
• -
• Cooperating is better if PVm>PVd
• -
• -
• -
• If p=1 this requires that the discount factor if higher than 52.9%. 
• The grim trigger strategy s* is a SPNE if Rp>0.529

• If an infinetly repeated game has a set of pay-offs that exceed the one-shot Nash equilibrium pay-offs for every firm then any set of feasbile pay-offs that are preferred by all firms can be supported as subgame perfect equilibria for the repeated game.
• Example
  • 2 identical firms MC=30 P=150-Q. 
  • If the firms compete they each earn £1600
  • IF the collude they perfectly share the monopoly profits of £3600.
  • Folk Theorm says that any point in this traingle is a potential equilibrium for the repeated game.

• Monopoly outcome may not be feasible- too strong temptation to cheat but folk theorem says collusion is still possible. 
• -
• -
• Profit from collusion
• -
• -
• Profits for deviate
• -
• -
• Cheating on the cartel does not pay so long as:
• -
• -
• Critical value of RP which defection on the cartel does not pay is:
• -
• -

1. Potential for Monopoly Profit

• Demand relatively elastic
• Ability to restrict entry

2. Low Costs of Reaching a Cooperative Agreement

• Small number of firms in the market
  • lowers search, negotiation and monitoring costs
  • makes trigger strategis easier and speedier to implement
• Similar production costs- avoids the problem of side payments
• Lack of significant product differentiation
  • simplifies negotation and monitory - dont need to agree on prices/quotas for every part of the product

3. Low Costs of Maintaining the Agreement

• use mechanisms to lower costs of detecting cheating
• remove temptation to cheat 
  • "Meet the competition" -guarntees competition are using the same price so higher prices are easier to sustain

4. Frequent market interactions

• makes trigger strategies more effective

5. Stable Market Conditions

• makes detection of cheating easier

6. Rapid Market Growth

• Cheating runs the risk of giving up the larger profits the cartel will generate as market grows.

• Tries to deter cartel formation.
• Probabilty of prosecution is a. Probality of not is (1-a)
• Punishment if F.
• -
• -
• -
• In increase in F will increase the threshold p*, decrease expected cartel profits and make cartel formation less likely
• Optimal policy will cut back an expensive detection efforts and balance this by imposing heavy fines for those cartels that are detected.