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An Illegal Agreement Among Firms

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In an oligopoly, companies are interdependent; they are concerned not only with their own decisions about the quantity to be produced, but also with the decisions of other companies in the market. Game theory provides a useful framework for thinking about how companies can act in the context of this interdependence. Specifically, game theory can be used to model situations in which each player must also think about how other actors might react to this action in deciding how to proceed. Game theory provides a framework for understanding how companies behave in an oligopoly. For example, game theory may explain why oligopolies have difficulty maintaining collusive agreements to generate monopoly gains. While together, companies would be better off if they worked together, each company has a strong incentive to defraud and under-coerce competitors in order to increase their market share. Because the incentive to default is strong, companies cannot even enter into a collusive agreement if they do not perceive that there is a way to effectively punish defectors. The Cournot model, where companies compete for production, and the Bertrand model, where companies compete for price, describe the dynamics of the duopoly. 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. Agreements may also occur in auction markets where independent companies coordinate their bids (bid manipulation). [9] For example, suppose there are two companies in the toaster market with a specific demand function.

Company A will determine the production of Company B, keep it constant and then determine the rest of the market demand for toasters. Company A will then determine its increasingly profitable production for these residual needs, as if it were the entire market, and produce accordingly. Company B will simultaneously perform similar calculations in relation to the company A. Cournot duopoly is an economic model that describes an industry structure in which companies compete at the level of production. The model assumes that the composition of the monopoly price and the availability of half of the market are the best thing that companies could do in this scenario. However, the Nash balance alone of this model is not the only Nash balance of this model if the marginal costs that are the uncooperative result were not agreed upon and insisted. A variant of this traditional theory is the theory of folded demand. Businesses are faced with a drop in demand if, in the event of a price drop in a company, they are expected to follow this example in order to maintain their turnover. If a company increases its price, its rivals probably won`t follow, as they would lose the revenue gains they would otherwise get if they kept prices at the previous level. Lower demand potentially favours more competitive prices, as each company would benefit less from lower prices, in contrast to the advantages of neoclassical theory and certain game theory models such as Bertrand`s competition. [8] While game theory is important for understanding firm behaviour in oligopolies, it is generally not necessary to understand competitive or monopolized markets.