Chapter 13: Problem 1

In many oligopolistic industries, the same firms compete over a long period of time, setting prices and observing each other's behavior repeatedly. Given the large number of repetitions, why don't collusive outcomes typically result?

Short Answer

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Although oligopolistic firms continuously observe each other's behaviors and set prices, collusions do not commonly result due to the difficulty in maintaining them. The incentive to cheat on the agreement for higher short-term profits outweighs the long-term benefits of cooperation. Furthermore, the increasing number of firms makes coordination more challenging, preventing collusion. Regulatory authorities also discourage such practices as they are detrimental to healthy competition and consumers.

Step by step solution

Understanding Oligopoly

An oligopoly is a market form where a market or industry is dominated by a small number of sellers. Each oligopolist is likely to be aware of the actions of the others. As a result, decisions of one firm influence that of the others.

Understanding Price Setting and Observation

In an oligopolistic market, the firms repeatedly interact with each other. They set prices and observe each other's behavior. A firm can anticipate the possible reactions of its rivals to its price and output policies, which affect how it sets its prices.

Understanding Collusion

Collusion occurs when competitors in the market secretly agree to cooperate for their benefit, often to the detriment of consumers. This cooperation could result in setting high prices and earning higher profits.

Why Collusion does not Typically Result

Collusion doesn't typically occur due to several reasons. Collusion is difficult to maintain because each firm has an incentive to break the agreement to earn more profits. Regulatory authorities also discourage such practices because they reduce competition and can be harmful to consumers.

The Relationship between Repetitions and Collusion

Although there are numerous repetitions, these do not lead to collusion because the short-term incentive to cheat and get more profits outweighs the long-term benefits of cooperation. Furthermore, collusion becomes more difficult with an increasing number of firms, as coordinating becomes harder.