Consider two firms that sell substitute products and compete with one another in
ID: 1104181 • Letter: C
Question
Consider two firms that sell substitute products and compete with one another invarious markets across the country. As a casual observer of the market, you do not know the demand function for each of these products nor the firms’ cost functions. You read a newspaper article that claims these two firms are colluding for the following reasons:
(a) The firms’ price changes match each other quite closely over time
(b) When it is known or likely that their costs have risen, both firms raise their prices
(c) When a rival firm selling a substitute product entered the market, both of the original firms lowered their prices 1
(d) There are markets where only one of the firms is operating, indicating that the firms have divided the country into local monopolies among themselves
For each of the reasons, explain whether you agree or disagree with the newspaper article’s author and reference the predictions of the oligopoly models we have examined whenever relevant.
Explanation / Answer
a) Since in Oligopoly there is too much interdependency on each other and also since there are only two manufacturer in this case and the products are substitute and for Oligopoly the products are almost similar or slightly differentiated and hence we can expect prices to move closely in the long run but if the prices increases without any substantial cost increase and one is following other at each instance then we can suspect them of colluding
b) In oligopoly for marginal cost increase firm generally don't change the prices but if the cost has increased substantially then they will definitely increase the price since rise in Input gives them the solid basis for price increase and also helps protect companies from antitrust prosecution so we need to determine whether the cost change is pretty minimal or has not increased for sure and the companies have increased the prices in such cases we can suspect companies to be colluding
c) Since at higher prices and if economies of scale are not too steep then new competitor can easily enter and survive at pretty small market share hence generally in such cases for oligopoly the firms tend to effect prices so as to make it difficult for the new firm and hence we can not suspect them of colluding basis this
d) This also depends upon transportation and logistic cost if this is same for both the firm then we can definitely suspect them of colluding but if this is not the case then we can expect that because of transportation cost differences they are operating in different markets so we need more information to identify the cause for this.