Question

Explain why it is difficult to maintain collusion in cartels. What factors would make collusion easier? What factors would make it harder? Be sure to use game theory in your answer. Feel free to draw a picture. Please type the text portion of your response.

Answer 1

Cartels refer to a group of large dominant firms in an oligopoly market who come together to make joint decisions on pricing and output in order to maximize profits.

Factors which make collusion easier:

· Limited number of members

· Ability of members to have free flow of information without any doubt or scope of cheating

· Ability of firms to observe each other’s actions

· Contractual agreements among members to deter cheating

Factors which make collusion harder:

· Incentive of members to cheat on an individual level

· Lack of formal exchange of information can lead to inefficient decision making by cartels

· Increase in number of members

Since a collusion represents the game theory payoff structure for an oligopoly where the members have an incentive to cheat and gain higher payoffs, it is of utmost importance that clear communication is present among the members to ensure best decision is made to maximize profits of the cartel.