Consider two firms that sell substitute products and compete with one another in
ID: 1104187 • Letter: C
Question
Consider two firms that sell substitute products and compete with one another in various 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 prices1
(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. Agree since ths is a form of tacit collusion where the existing firms collude coverty in order to reduce competition i.e they avid cutting prices and effect the market share of the other knowing that hteir response will form the basis of the the others reaction.
b. Disagree since this is nt a firm enough reason for collusion. In case of rising costs firm's raise prices to cover hteir increasing costs and this movement by firms does not necessarily imply collusion.
c. Agree since lowering prices by both firms on entry of a rival firm is indicative of collusion in order to make it difficult for the new entrant to survive in the market while selling its good at ahigh price where by the existing firms sell the substitutegood at a lower price.
d. Agree since the firms sharing market space is indicative of tacit collusion.