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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.