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A Dynamic Oligopoly with Collusion and Price Wars

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Author Info
Chaim Fershtman
Ariel Pakes

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Abstract

Most of the theoretical work on collusion and price wars assumes identical firms and an unchanging environment, assumptions which are at odds with what we know about most industries. Further that literature focuses on the impact of collusion on prices. Whether an industry can support collusion also effects investment incentives and hence the variety, cost, and quality of the products marketed. We provide a collusive framework with heterogeneity among firms, investment, entry, and exit. It is a symmetric information model in which it is hard to sustain collusion when either one of the firms does not keep up with the advances of its competitors, or a low quality' entrant enters. In either case there will be an active firm that is quite likely to exit after it deviates, but if one of the competitors is near an exit state the other incumbent(s) has an incentive to price predatorily (that is to deviate themselves). We use numerical analysis to compare an institutional structure that allows for collusion to one which does not (perhaps because of an active antitrust authority). Price paths clearly differ in the two environments; in particular only the collusive industry generates price wars. The collusive industry offers both more and higher quality products to consumers, albeit often at a higher price. The positive effect of collusion on the variety and quality of products marketed more than compensates consumers for the negative effect of collusive prices, so that consumer surplus is larger in the collusive environment.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6936.

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Date of creation: Feb 1999
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Handle: RePEc:nbr:nberwo:6936

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Find related papers by JEL classification:
C71 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Cooperative Games
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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  1. Weintraub, Gabriel Y. & Benkard, C. Lanier & Van Roy, Benjamin, 2007. "Computational Methods for Oblivious Equilibrium," Research Papers 1969, Stanford University, Graduate School of Business. [Downloadable!]
  2. Ulrich Doraszelski & Kenneth L. Judd, 2005. "Avoiding the Curse of Dimensionality in Dynamic Stochastic Games," NBER Technical Working Papers 0304, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. George Symeonidis, 2001. "Price Competition, Innovation and Profitability: Theory and UK Evidence," Economics Discussion Papers 530, University of Essex, Department of Economics. [Downloadable!]
    Other versions:
  4. Doraszelski, Ulrich & Satterthwaite, Mark, 2007. "Computable Markov-Perfect Industry Dynamics: Existence, Purification, and Multiplicity," CEPR Discussion Papers 6212, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Christian Bayer, 2004. "The Other Side of Limited Liability: Predatory Behavior and Investment Timing," Industrial Organization 0407001, EconWPA. [Downloadable!]
  6. Lewis Evans and Patrick Hughes, 2003. "Competition Policy in Small Distant Open Economies: Some Lessons from the Economics Literature," Treasury Working Paper Series 03/31, New Zealand Treasury. [Downloadable!]
  7. Rey, Patrick, 2002. "Towards a Theory of Competition Policy," IDEI Working Papers 121, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
  8. Markku Stenborg, 2004. "Forest for the Trees: Economics of Joint Dominance," European Journal of Law and Economics, Springer, vol. 18(3), pages 365-385, December. [Downloadable!] (restricted)
  9. Markku Stenborg, 2002. "Economics of Joint Dominance," Discussion Papers 834, The Research Institute of the Finnish Economy. [Downloadable!]
  10. Luís Cabral, 2005. "Collusion Theory: Where to Go Next?," Journal of Industry, Competition and Trade, Springer, vol. 5(3), pages 199-206, December. [Downloadable!] (restricted)
  11. David S. Evans & Michael Salinger, 2004. "An Empirical Analysis of Bundling and Tying: Over-the-Counter Pain Relief and Cold Medicines," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  12. Gabriel Weintraub & C. Lanier Benkard & Ben Van Roy, 2005. "Markov Perfect Industry Dynamics with Many Firms," NBER Working Papers 11900, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Tom Björkroth, 2002. "Market Structure and Welfare in the Finnish Market for Long-Distance Telecommunications," Finnish Economic Papers, Finnish Economic Association, vol. 15(2), pages 87-101, Autumn. [Downloadable!]
  14. Ulrich Doraszelski & Sarit Markovich, 2004. "Advertising Dynamics and Competitive Advantage," Computing in Economics and Finance 2004 61, Society for Computational Economics. [Downloadable!]
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    Other versions:
  17. Weintraub, Gabriel Y. & Benkard, C. Lanier & Van Roy, Benjamin, 2007. "Markov Perfect Industry Dynamics with Many Firms," Research Papers 1919r, Stanford University, Graduate School of Business. [Downloadable!]
  18. David S. Evans & Michael Salinger, 2005. "Curing Sinus Headaches and Tying Law: An Empirical Analysis of Bundling Decongestants and Pain Relievers," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  19. George Symeonidis, 2007. "Downstream Competition, Bargaining and Welfare," Economics Discussion Papers 625, University of Essex, Department of Economics. [Downloadable!]
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  20. Gabriel Y. Weintraub & C. Lanier Benkard & Benjamin Van Roy, 2005. "Markov perfect industry dynamics with many firms," Working Paper Series 2005-23, Federal Reserve Bank of San Francisco. [Downloadable!]
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