Archive for the 'collusion' Category

Feb 25 2015

Ways firms may collude in Oligopolistic markets

Oligopolistic markets are unique among the four market structures we have studied. Unlike perfect and monopolistic competition and pure monopoly,the individual firms in an oligopoly are heavily interdependent of one another with regards to business decisions relating to price, service, location, advertising, product differentiation, and so on. The actions of one firm will impact heavily the profitability of its major competitors.

This sometimes gives oligopolies an incentive to collude with one another. Collusion, as defined by Investopedia is A non-competitive agreement between rivals that attempts to disrupt the market’s equilibrium. By collaborating with each other, rival firms look to alter the price of a good to their advantage.”

Collusion can take many forms, and is not always overt in nature (in other words, it may be going on without any actual discussions between the firms colluding). Below are three ways firms may collude:

Overt, formal collusion – the cartel model: A cartel, as defined by Investopedia, is “An organization created from a formal agreement between a group of producers of a good or service, to regulate supply in an effort to regulate or manipulate prices.” An example of a cartel is California’s Raisin Administrative Committee. Listen to this story to learn more.

  • California’s raisin producers meet annually to determine the quantity of raisins that should be released to the market
  • In years where the crop is very good, they will “divert” raisins to the “reserve” and reduce the supply
  • This keeps the price high.
  • By colluding through the cartel, the raisin growers get to sell their output for a higher price and the total quantity released to the market is less than would be released without the cartel. The cartel makes the raisin market look more like a monopoly (higher price, lower quantity, less consumer surplus).

Tacit, informal collusion – the price leadership model: Not all collusion is formal and overt. In fact, because of the negative impact collusion has on consumers (higher price, lower quantity), it is actually illegal in many countries and government will investigate and possibly prosecute firms that attempt to collude to raise prices (see this story about the US Justice Department investigating the a proposed merger between two food wholesale companies). In order to avoid investigation by the government, firms often engage in tacit collusion, when firms agree to keep prices high without explicitly saying so.

Beer market in the US: The story about the US beer market indicates that a form of tacit collusion may be taking place between the two largest beer producers.

  • When Anheuser Busch/InBev raises the prices for its beers, its main competitor (Miller/Coors), tends to do so too.
  • The two firms control 65% of America’s beer market. When both raise their prices, demand tends to be relatively inelastic, allowing both firms to enjoy higher revenues.
  • If the two firms were acting competitively, the smaller firm (Miller/Coors), would most likely ignore price increases by Anheuser Busch/Inbev, and enjoy the greater demand resulting from the larger firm’s consumers switching beers.
  • The “price leadership” model of tacit collusion is when one firm (typically the largest in the market) raises prices and competitors willingly follow suit, leading to a smaller decrease in quantity demanded for the larger firm and increased revenues for all firms in the market.

Grocery stores in the United Kingdom: Another example of tacit collusion can be seen in the UK grocery market. The big grocery chains offer “price-match guarantees” that promise their consumers that they will never pay less for their groceries at another supermarket.

  • Sellers have no incentive to lower their prices because they will be less likely to steal the competition’s customers when the competition has a price-match guarantee.
  • Through such a scheme, all grocery chains are likely to keep their prices HIGH and “price-wars” (which benefit consumers), are much less likely to occur.
  • The price-match guarantee (which on the surface appears to be good for consumers) acts as a form of tacit collusion and results in consistently higher prices for groceries in the UK.

Graphing collusive oligopolies: Under competition, oligopolists that lower their prices may initiation a “price war” due to the strong incentive any price cut creates for competitors to also cut prices. Likewise, price increases are less likely under competition because price increases tend to be ignored as the competition gains market share when the first firm raises its price. These assumptions of competitive oligopolies are reflected in the “kinked demand curve” model.

noncollusive

Under a collusive oligopoly, price increases is greater and the chance of price wars is much smaller. Demand for an individual firm’s output when it is colluding with its competitors looks more like the demand for a monopolist’s output; it is relatively inelastic, even when the firm raises its prices (since price increases are more likely to be matched rather than ignored). The collusive oligopolists demand curve looks like this.

collusion

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Feb 24 2015

The Raisin Cartel – collusive agreements and why they fall apart

Planet Money – The Raisin Outlaw

When a competitive industry acts like a monopoly, the consumers are the losers, the producers are the winners, and a market that may have been efficient is made less so. But how can this type of collusion be possible, and what happens when collusive agreements fall apart?

NPR’s Planet Money tells the story of a collusive agreement, and what happened when one producer betrayed the agreement.

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Apr 20 2012

UPDATE: Golden Balls, Game Theory, the Prisoner’s Dilemma, and the cold rationality of human behavior!

The excellent Radiolab has now done a story about Golden Balls. After watching the videos and reading the post below, listen to this story.


In my original “Golden Balls” blog post (see below), written almost three years ago after I saw a clip of the finale in an episode of the British game show, Golden Balls, I analyzed the actions of Sarah and Steve, who  had to decide whether they would split or steal a jackpot of 100,000 British pounds. The contestants had one minute to try to convince one another that they would split the money; but when it came down to it Sarah stole and Steve split, meaning Sarah got to keep the whole jackpot and Steve went home with nothing.

In that original post, I proposed that Steve’s best chances for going home with any money would have been “for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent.”

In a recent episode of the same game show, a contestant followed a similar strategy to that I suggested Steve should have taken. Watch the clip below, from a February 2012 episode of Golden Balls.

In this episode, Nick immediately takes control of the negotiations by insisting that he is going to steal, which is a very unorthodox approach to this game, in which the traditional strategy is to try and convince your opponent that you are going to split. By establishing a credible threat to steal, Nick puts all the pressure on Ibraham to decide only one of two things:

  1. Does Ibraham trust that Nick will split the money with him after he has stolen the full jackpot, and
  2. Would Ibraham rather both of them go home without any money at all than Nick win the jackpot and possibly not split it with him later on?
Nick’s strategy is brilliant. By the end of the negotiation, Nick has convinced Ibraham 100% that he is going to steal the money. Ibraham may only have had a confidence level of 50% that Nick was honest about splitting the money with him after the show, but with a 50% confidence level, Ibrahim’s possible payoffs are:
  • Choose steal and go home with nothing.
  • Choose split and have a 50/50 chance of going home with half the jackpot (based on his level of confidence in Nick’s promise to split the money after the show).
In other words, with a jackpot of 14,000 pounds, the payoffs for Ibrahim became:
  • If he splits: 0 pounds or 0.5(14,000) = 7,000 pounds
  • If he steals: 0 pounds or 0 pounds (assuming his confidence level in Nick’s intention to steal is 100%).
Clearly Ibraham now has a dominant strategy: to split. In the typical version of this game, a player’s dominant strategy is always to steal (as explained below), since the possible payoffs are:
  • If you split: 0 pounds or half the jackpot
  • If you steal: 0 pounds or the whole jackpot.
But because Nick has convinced his opponent that he will steal, and then split the winnings, Ibraham’s dominant strategy shifted to split, since the possible payoffs have changed. Ultimately, Ibraham does what is most rational given his confidence in Nick’s threat to steal, and that is to split. Ibraham then chooses split (as he should), but then to everyone’s surprise, Nick chooses split, not steal as he had threatened to do throughout the negotiation. This a surprising twist, since from Nick’s perspective stealing is clearly now a dominant strategy! Nick had convinved Ibraham to split, which means Nick faced a greater payoff by stealing. But by splitting, Nick shows that he had intended to split all along, but first needed to convince Ibraham otherwise to establish splitting as Ibraham’s dominant strategy.
What a thrilling game! I won’t even bother getting into how this relates to economics today, I’m still shaking with excitement over the outcome!
Original Golden Balls post:
Teaching the Prisoners’ Dilemma Will Never Be the Same Again « Cheap Talk

Rarely does such a perfect illustration of the Prisoner’s Dilemma come along for Econ teachers to use in their classroom:

The payoffs are clear:

Each player has a weakly dominant strategy, which is to choose to steal. By choosing to steal, the player has a chance at maximizing his own payoff, but will do no worse than he would if his opponent also chooses to steal and at least will have the satisfaction of thwarting his opponent’s attempt to steal the money.

There are three Nash equilibria in the game, which are outcomes at which a player can not do better on his or her own by changing his or her strategy. The outcome Steve was hoping for by chosing “split” (50/50) was not a Nash equilibrium because Sarah knows she can do better if she chooses steal when Steve chooses split. Steve doomed himself by choosing split because he should know that Sarah’s dominant strategy is to choose steal. However, Sarah would also have doomed herself by choosing split because she should assume that Steve would also chose steal since steal is a dominant strategy for him too.

John Nash, who pioneered the field of Game Theory, assumed that humans were coldly rational, self-interested, deceptive creatures that would not hesitate to stab one another in the back to get what was best for themselves. His theory of human behavior is only partially proven correct in this game, in which Steve is shown to be the sucker and Sarah the coldly rational self-interested player. The best chance for Steve to go home with any money would have been for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent. Then again, any promise Sarah makes she could later break, thus further empowering the players to choose steal.

Discussion questions:

  1. What in the world is going on here? Why did Sarah choose steal rather than collaborate with Steve and share the $100,000?
  2. Was Steve totally wrong to choose split? What would you have done in his situation?
  3. How do the choices faced by Steve and Sarah relate to the choices faced by firms in oligopolitic markets? Now that you’ve seen this video, can you explain why collusive agreements between oligopolists often fall apart? Why do cartels such as OPEC often fail to achieve the high price targets agreed upon in meetings of their leaders?

111 responses so far

Sep 14 2010

Bali’s Oligopolistic Scuba operators

A few summers ago, my wife and I spent three weeks travelling around the island of Bali in Indonesia. For six of those days we rented a jeep and circumnavigated the island. Our first stop was for two days of scuba diving in the northeast region of Ahmed. As we drove along the seven beaches near Ahmed, we observed there were around ten dive operators offering packages for the local dive spots (including one of Asia’s most famous dives, the WWII-era USS Liberty wreck). Based on our Lonely Planet recommendation, we settled on Eco-Dive, where we paid $60 a day for two dives and all our gear rental. We felt good about this rate and agreed that $60 was a fair and competitive price for a day of diving.Jukung- traditional wind powered trimaran used for fishing in Ahmed

Our next stop, Pemuteran, a remote and relatively undeveloped area on the northwest coast just across the straits from Java, is also known for its great diving. On our first morning in Pemuteran, my wife and I strolled along the beach and found that there were only three dive operators to choose from! And guess what, they all charged between $95-$105 for a day of diving. That’s around 60% more than the operators in Ahmed charged! In the end, we decided to do only one day of diving in Pemuteran, and elected to spend our second day there reading by the pool.

Discussion Questions:

  1. What was the difference between the scuba diving markets in Ahmed and Pemuteran? Which market was more competitive? Which of the four market structures did the two markets most resemble: perfectly competitive, monopolistically competitive, oligopolistic or monopolistic?
  2. How were the dive operators in Pemuteran able to charge 60% more than the operators in Ahmed?
  3. What do you think is keeping one of the three dive operators in Pemuteran from lowering their price to, say, $60 for a day of diving? How would the other two operators respond? Would this be good or bad for the dive operators of Pemuteran? Would it be good or bad for scuba divers?
  4. Assuming that the cost of opening a dive operation was relatively low, and there were no government or other barriers to doing so in Pemuteran, what do you suspect will happen in the Scuba diving market as the tourism industry continues to develop in the remote town of Pemuteran? Explain.
  5. Which village’s dive operators do you think were more “efficient” in their use of resources? Explain.

51 responses so far

Jun 26 2007

Bali economics: “thinking like an economist” on the Island of the Gods!

Legong: a traditional dance practice in the artisan community of UbudIF you’ve visited this blog in the last two weeks, you’ve probably seen the picture below of a beautiful sunset, a distant island and a wispy palm. Turns out I stayed two nights on the beach that picture was taken from, Ahmed in Bali’s remote northwest corner! What a beautiful island Bali is! Unlike many touristy places in Southeast Asia such as Phuket and Samui in Thailand, Bali is an island paradise that has managed to develop a thriving tourist industry while simultaneously maintaining its distinct Hindu culture and traditions that awe visitors and help them understand why it’s called the “island of the gods”. Not only do most Balinese outside the one or two major cities still live in the traditional style houses, but they actively practice their unique form of Hinduism (imported from India via Java in the 11th century), maintain the traditional forms of dance and religious ritual, and sustain themselves by practicing any number of artistic trades rooted in the island’s rich and colorful history. Indeed, in most villages we passed through, it was hard to tell which buildings were temples and which were houses. As much of Indonesia and the rest of Asia have rushed head-on into the age of globalization (often meaning westernization), Bali has thankfully held on to and even fostered one very precious and all too rare commodity: its own history.Art is everywhere in Bali. These statues look over Ahmed's fishing fleet and protect fishermen on their risky voyages to sea.

Certainly after a year in Shanghai, where the closest thing to religion among urban Chinese is the pursuit of wealth, a couple of weeks in the rich spiritual heart of an ancient Hindu island culture was just what I needed to remind myself what was important in life. But alas, once an economist always an economist, and even with a thousand years of rich cultural heritage to turn my attention from school and economics, I could not help but notice the intricacies of Bali’s economy and how tourism and globalization have affected this remote island culture. My next few posts will cover casual observations made during my 16 day trip to Bali about its local economy and how it has been shaped by the global economy and tourism.

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