An Agreement Among Members Of An Oligopoly To Set Prices And Production Levels
Whether cartel members choose to defraud the cartel depends on the fact that the short-term revenues from the fraud outweigh the long-term losses resulting from the eventual bankruptcy of the cartel. It also depends in part on the difficulty for companies to monitor compliance with the agreement by other companies. If surveillance is difficult, it is likely that a member will get away with fraud for longer; Members would then be more likely to cheat and the agreement would be more unstable. Like the prisoner`s dilemma, cooperation in an oligopoly is difficult to maintain, because cooperation is not in the best interests of the various actors. However, the collective bottom line would be improved if companies cooperated and were thus able to maintain low production, high prices and monopolistic profits. The prisoner`s dilemma is a specific type of game in game theory that shows why collaboration can be difficult to hold for oligopolists, even if it is beneficial for both parties. In the game, two members of a criminal gang are arrested and imprisoned. The prisoners are separated and left to see their possibilities. If both prisoners confess, each is serving a two-year prison sentence.
If one confesses, but the other denies the act, the one who confessed becomes free, while the one who denied the crime received a three-year prison sentence. If both deny the crime, they will serve only one year in prison. Betraying the partner with a confession is the overriding strategy; This is the best strategy for each player, no matter how the other player plays. This is called the Nash balance. The result of the game is that the two prisoners follow an individual logic and betray if they had achieved a better result together, if they had both cooperated. Companies in an oligopoly can increase their profits through collusion, but collusive agreements are inherently unstable. The Bertrand model describes the interactions between companies that compete for the price. Companies set maximum prices in response to what they expect from a competitor. The model is based on the following assumptions: Bertrand Duopoly: The graph shows the reaction function of a company that competes for the price.
If P2 (the price set by company 2) is lower than marginal costs, enterprise 1 in marginal prices (P1-MC). If Firm 2 price above MC, but below monopoly prices, company prices 1 just below company 2. When prices are fixed 2 above the monopoly price (PM), fixed price 1 at the monopoly level (P1-PM). The Cournot model focuses on the production decision of a single company. The company determines its rival`s level of production, evaluates the rest of the market demand, and then changes its own level of production to maximize profits. It is considered that the company`s production decision will not affect its competitor`s production decision. An agreement is a formal collusive agreement between companies with the aim of increasing profits. A traditional example of game theory and the prisoner`s dilemma in practice are soft drinks.
Coca-Cola and Pepsi compete in an oligopoly and are therefore very competitive against each other (since they have limited other competitive threats). Given the similarity of their products in the soft drink industry (i.e. different species of soda), any price differential of a competitor is considered an act of non-compliance or betrayal of an established status quo. OPEC: In the 1970s, OPEC members successfully agreed to reduce global oil production, resulting in increased profits for member countries.