ii.) Tit-for-Tat.
Trigger strategies are not the only way to reach the non-co-operative collusion. Another famous strategy is Tit-for-Tat, according to which a player chooses in the current period what the other player chose in the previous period. Cheating by either firm in the previous round is therefore immediately punished by cheating, by the other, in this round. Cheating is never allowed to go unpunished. Tit-for-Tat satisfies a number of criteria for successful punishment strategies. It carries a clear threat to both parties, because it is one of the simplest conceivable punishment strategies and is therefore easy to understand. It also has the characteristics that the mode of punishment it implies does not itself threaten to undermine the cartel agreement. This is because firms only cheat in reaction to cheating be others; they never initiate a cycle of cheating themselves. Although it is a tough strategy, it also offers speedy forgiveness for cheating, because once punishment has been administered the punishing firm is willing once again to restore co-operation. Its weakness is in the fact that information is imperfect in reality, so it is hard to detect whether a particular outcome is the consequence of unexpected external events such as a lower demand than forecast, or cheating, Tit-for-Tat has a capacity to set up a chain reaction in a response to an initial mistake.
d.) Finite game case, Kreps approach.
Lets now return to the question of how collusion might occur non-co-operatively even in the finitely repeated game case. Intuition said that collusion could happen- at least at the earlier rounds- but the game theory apparently said that it could not. Kreps et al. (1982) offered the elegant solution to this paradox. They relax the assumption of complete information and instead suppose that one player has a small amount of doubt in his mind as to the motivation of the other player. Suppose A attaches some tiny probability p to B referring- or being committed- to playing the “trigger” strategy. In fact it turns out that even if p is very small, the players will effectively collude until some point towards the end of the game. This occurs because its not worth A detecting in view of the risk that the no-collusive outcome will obtain for the rest of the game, and because B wishes to maintain his reputation for possibly preferring, or being committed to, the “trigger” strategy. Thus even the small degree of doubt about the motivation of one of the players can yield much effective collusion.
5. The motives for retaliation.
The motives for retaliation differ in three approaches. In the first approach, the price war is a purely self-fulfilling phenomenon. A firm charges a lower price because of its expectations about the similar action from the other one. The signal that triggers such a non-co-operative phase is previous undercutting by one of the firms. The second approach presumes short-run price rigidities; the reaction by one firm to a price cut by another one is motivated by its desire to regain a market share. The third approach (reputation) focuses on intertemporal links that arise from the firm’s learning about each other. A firm reacts to a price cut by charging a low price itself because the previous price cut has conveyed the information that its opponent either has a low cost or cannot be trusted to sustain collusion and is therefore likely to charge relatively low prices in the future.
6. Conclusion.
So far I have discussed the collusion using some simple example with a choice of output levels made by the two firms. But there may be several firms in the industry, and in fact firms have a much broader choice. It may be that their decision variable is price, investment, R&D and advertising. Nevertheless the more or less the same analysis could be applied in each of the case.
I have examined different assumptions and predictions, which allow or do not allow the possibility of collusion. In reality such thing as collusion definitely takes place, if it had not, there would not have been any strong an ambiguous discussion of this topic. But I think it would be appropriate to end this essay with an explicit reminder that once we leave the world of perfect competition, we lose the identity of interests between consumers and producers. So, the discussion of benefits to firms in oligopoly that arise from finding strategies to enforce collusive behaviour might well have been the discussion of the expenses of consumers.
7. Bibliography.
1. J.Vickers, “Strategic competition among the few- Some recent developments in the economics of industry”.
2. J.Tirole, “The theory of industrial organisation”. Ch 6.
3. Estrin & Laidler. “Introduction to microeconomics”. Ch 17.
4. W.Nicholson, “Microeconomic theory”. Ch 20.