🧃intermediate microeconomic theory review

key term - Collusion

Definition

Collusion is a strategic agreement between competing firms to coordinate their actions, typically to increase profits by reducing competition. This can involve setting prices, limiting production, or dividing markets among themselves. In repeated games, collusion becomes more feasible as firms can use past interactions to enforce cooperative behavior and sustain agreements over time.

5 Must Know Facts For Your Next Test

  1. Collusion is often difficult to maintain because firms have incentives to cheat on the agreement for short-term gain, leading to potential breakdowns.
  2. The Folk Theorem suggests that in repeated games, collusion can be sustained if players value future payoffs enough, as it provides a mechanism for punishing deviations from agreed-upon strategies.
  3. Collusion can lead to higher prices and reduced consumer welfare, making it a primary concern for regulatory authorities that monitor anti-competitive behavior.
  4. The effectiveness of collusion can depend on market conditions, such as the number of firms involved, the homogeneity of products, and the frequency of interactions between firms.
  5. Firms may use signaling and communication strategies to facilitate collusion in repeated games, increasing the likelihood of maintaining cooperation.

Review Questions

  • How does the concept of repeated games influence the potential for collusion among firms?
    • In repeated games, firms interact multiple times, which allows them to establish a pattern of behavior over time. This setting enables firms to enforce cooperative agreements through mechanisms like punishment for deviation. If firms can effectively communicate and monitor each other’s actions, they are more likely to sustain collusion, as future profits become crucial for maintaining cooperation.
  • What role does the Folk Theorem play in understanding how collusion can be achieved and maintained in competitive markets?
    • The Folk Theorem indicates that in infinitely repeated games, a wide variety of outcomes can be sustained as equilibria if players sufficiently value future payoffs. This means that collusive outcomes can be achievable if firms are willing to cooperate and can impose penalties on those who deviate from agreed-upon strategies. It highlights the importance of trust and future interactions in maintaining collusion.
  • Evaluate the implications of collusion on market outcomes and consumer welfare, considering both short-term benefits and long-term consequences.
    • Collusion typically leads to higher prices and reduced output, negatively impacting consumer welfare in the short term. While firms may enjoy increased profits from coordinated actions, the long-term consequences can include regulatory scrutiny and potential legal penalties. Additionally, sustained collusion can stifle innovation and competition in the market, ultimately harming consumers by limiting choices and driving prices even higher. Understanding these dynamics is essential for analyzing firm behavior and market structure.