PRISONER’S DILEMMA & COLLUSIVE OLIGOPOLIES

A2 Economics

Starter: Banking Sector

Aims and Objectives

Aim:

• To understand the prisoner’s dilemma and collusion in an

oligopoly.

Objectives:

• Discuss the oligopolistic banking sector.

• Analyse and apply the prisoner’s dilemma model.

• Evaluate the reasoning behind a collusive oligopoly.

Prisoner’s Dilemma in the Mobile Phone Industry

• Read the case study.

• Create your own pay off matrix from the case study.

• Discussion

Prisoner’s Dilemma in the Mobile Phone Industry

Firm A: …………

Firm

B: …

……

……

Collusion in an Oligopoly

• Game theory suggests that sometimes, firms would be better off if they colluded, rather than competed interdependently.

• Colluding limits possibilities of choosing the wrong strategies.

• Supermarkets Article.

Formal Collusion

• An agreement exists between firms about price or output policies.

• Range from restrictive agreements refusing to supply outlets which sold below the agreed price, to..

• …agreeing to raise or set prices together.

• Overall aim is to joint profit maximise & remove uncertainty.

Formal Collusion: Cartel• Cartel: group of firms colluding.

Firm A

Firm B

Firm C

Firm D

Firm E

Members of the Cartel

Least productively efficient or highest cost firm.

PRICE RING

Formal Collusion: Cartel• 5 firms jointly agree to charge a price to keep firm E in the

market (least efficient firm).

• Why?

• In a competitive market firm E would have to reduce costs or go out of business.

• Cartel agreements allow inefficient firms to stay in business and more efficient firms to enjoy supernormal profits.

Cartels: Supernormal Profit Diagram

• Draw

• (D=AR) = MR = MC

• Supernormal profits in a colluding oligopoly.

Formal Collusion: Cartel

• Cartels can achieve a better outcome for all firms concerned.

• However they are not likely to be good for consumers.

• Higher prices and restriction of choice.

• Cartels tend be illegal due to their anti competitive nature

Formal Collusion: Legal Cartels

• Joint product development

• Such as Ford Galaxy, Seat Alhambra, VW Sharan which were jointly developed by VW and Ford.

• Improved health and safety and product and labour standards in the industry.

Plenary

• Draw the cartel supernormal profits diagram.

• Explain the benefits and disadvantages of cartels.