1. Game Theory!

2. Cartels
A group of suppliers who try to act together in order to reduce supply, raise prices, and increase profits.
A group of supplied who try to act as AS IF they were a monopolist
Example: OPEC
Question to answer: When will cartels be able to achieve their goal of being a monopolist?

3. Game Theory A study of strategic decision-making
A decision in making situations that are interactive
Example: Craps players make decisions, pokers players make strategic decisions
Game theory is used to analyze cartels because the best decision of one cartel member depends on the decisions of every other cartel member which in turn depends on the decisions of every other cartel member

4. Game Theory
Also used to study war, romance, business decisions, evolution, voting and other situations involving interactions
Game theory is applied to the economics of network of goods
A network of goods is a good who value to one consumer increases the more that other consumers use the good
Ex. Cell phones

5. Cartels and Game Theory
Why did the price of oil more than triple in ?
Saudi Arabia, a cartel of oil exporting countries cut back on their production of oil

6. Cartels and Game Theory
Very few cartels can move in an industry from competition to pure monopoly
OPEC seems to be all powerful but in reality, very few cartels are
UNLESS…..they have strong government support
Would have much control over market price for a very long time

7. Cartels and Game Theory
Cartels tend to collapse due to three reasons:
Cheating by cartel members
New entrants and demand response
Government prosecution

8. 1. Cheating by cartel members
For oil-exporting nations, if they worked together to reduce production and raise prices, it would succeed
Cartel members earn high profits on each barrel of oil that comes out of the ground
BUT……members will cheat on the cartel agreement
They promise to reduce production but when everyone else reduces production and the price of oil rises…….some cartel members can and will cheat to increase their profits

9. Logic of Cheating….. No Cartel
Countries
Output per Country
Output
Profit per Country (per day) 10
10 MBD
100 MBD
$360 million
World Output
World Price
$36

10. Logic of Cheating….. Cartel
Countries
Output per Country
Output
Profit per Country (per day) 10
8 MBD
80 MBD
$400 million
World Output
World Price
$50

11. Logic of Cheating….. Cartel with One Cheater
Countries
Output per Country
Output
Profit per Country (per day) 9
8 MBD
72 MBD
$380 million 1
10 MBD
$475 million
World Output
82 MBD
World Price
$47.50

12. 1. Cheating by cartel members
The logic is simple, a single cartel member does not have extensive monopoly power, so cutting back production doesn’t raise the world price enough to make up for its loss of sales
What happens when nine countries cheat and only one country keeps its promise?

13. Logic of Cheating….. Cartel with Nine Cheaters and One Non-Cheater
Countries
Output per Country
Output
Profit per Country (per day) 1
8 MBD
$300 million 9
10 MBD
90 MBD
$375 million
World Output
98 MBD
World Price
$37.50

14. 1. Cheating by cartel members
Cheating pays when other firms keep their promise and cheating pays when other firms cheat
When a monopolist increases quantity beyond the profit-maximizing quantity, the monopolist hurts itself
When a cartel cheater increases quantity beyond the profit-maximizing quantity, the cheater benefits itself and hurts other cartel members

15. 1. Cheating by cartel members
When the decisions of two or more firms significantly affect each others’ profits, they are in a situation of interdependence.
The study of behavior in situations of interdependence is known as game theory.
The reward received by a player in a game—such as the profit earned by an oligopolist—is that player’s payoff.
A payoff matrix shows how the payoff to each of the participants in a two player game depends on the actions of both. Such a matrix helps us analyze interdependence.

16. Saudi Arabia’s Strategies
The Payoff Table
Russia’s Strategies
Cooperate
Cheat
Saudi Arabia’s Strategies
($400, $400)
($200, $500)
($500, $200)
($300, $300)
Saudi Arabia’s Payoff
Russia’s
Payoff

17. Saudi Arabia’s Strategies
The Payoff Table
Russia’s Strategies
Cooperate
Cheat
Saudi Arabia’s Strategies
($400, $400)
($200, $500)
($500, $200)
($300, $300)
Two numbers in each both of the table
are the payoffs to the players
Dominant Strategy – is a
Strategy that has a higher payoff than any other
Strategy no matter what the other player does
When Russia acts in their own interest and Saudi
Arabia acts in their own interest, the result is an
outcome that is in the interest of neither

18. The Prisoner’s Dilemma
If both players cooperate, fishing revenues can be maximized and the stock of fish will be maintained for future generations
BUT….if one player cheats, the other has an incentive to cheat and this will reduce the stock of fish below the best possible outcome and will eventually deplete the product
This describes situations where the pursuit of individual interest leads to a group outcome that is in the interest of no one
Ex:
Japan’s Strategies
Cooperate
Cheat
United States’ Strategies
($400, $400)
($200, $500)
($500, $200)
($300, $300)

19. Prisoner’s Dilemma & Nash Equilibrium
An action is a dominant strategy when it is a player’s best action regardless of the action taken by the other player. Depending on the payoffs, a player may or may not have a dominant strategy.
A Nash equilibrium, also known as a non-cooperative equilibrium, is the result when each player in a game chooses the action that maximizes his or her payoff given the actions of other players, ignoring the effects of his or her action on the payoffs received by those other players

20. Repeated Interaction and Tacit Collusion
Players who don’t take their interdependence into account arrive at a Nash, or non-cooperative, equilibrium. But if a game is played repeatedly, players may engage in strategic behavior, sacrificing short-run profit to influence future behavior. In repeated prisoners’ dilemma games, tit for tat is often a good strategy, leading to successful tacit collusion.
Tit for tat involves playing cooperatively at first, then doing whatever the other player did in the previous period.
When firms limit production and raise prices in a way that raises each others’ profits, even though they have not made any formal agreement, they are engaged in tacit collusion

21. 2. New entrants and demand response
High prices of a cartel will attract new entrants
These entrants do not feel bound by previous agreements
Cartels are more successful when there are fewer substitutes for the cartelized good – implies less elastic demand
More subs are typically available in the long run than in the short run, do demand curves tend to become more elastic over time, thus limited a cartel’s power

22. 2. New entrants and demand response
With the ease of new entrants, it is easier to maintain a cartel in a natural resource than in a manufactured good
Two successful cartels – oil and diamonds

23. 2. New entrants and demand response
Natural resources are not the only “thing” in limited supply
A cartel may control access to some key inputs that cannot be easily duplicated
Ex. Major League Sports – NBA, NFL, MLB, MLS

24. 2. New entrants and demand response
NBA consists of 30 teams
Teams compete on the court but “collude” off the court
They use the NBA league structure to keep down player salaries – “salary cap”
If they do, face “the luxury tax”
Each team, when joining the NBA, agrees to limit how much spent on players
Example of a buyer’s cartel – result is that professional basketball salaries are lower than they should be

25. 3. Government prosecution
Cartels have been illegal since the Sherman Antitrust Act of 1890
Governments don’t always prosecute cartels and sometimes even support them
Most cartels operate with clear legal and governmental backing
Examples: OPEC, milk cartels, coal mining, agriculture, medicine

26. 3. Government prosecution
Government-enforced monopolies and cartels are one of the most serious problems faxing poor nations such as Mexico, Russia, Indonesia and Africa
Entrepreneurs who start new businesses sometimes find that the law force them out of competition with the small number of so-called untouchable big men who have cartelized the major sectors of the government

27. 3. Government prosecution
A government-supported cartel also means higher prices, lower quality of service and less innovation

28. Game Theory!

29. Cartels
A group of supplied who try to act as AS IF they were a monopolist
Example:

30. Game Theory
Example: Craps players make decisions, pokers players make strategic decisions
Game theory is used to analyze cartels because the best decision of one cartel member depends on the decisions of every other cartel member which in turn depends on the decisions of every other cartel member

31. Game Theory
Also used to study war, romance, business decisions, evolution, voting and other situations involving interactions
Game theory is applied to the economics of network of goods

32. Cartels and Game Theory
Why did the price of oil more than triple in ?

33. Cartels and Game Theory
Very few cartels can move in an industry from competition to pure monopoly
OPEC seems to be all powerful but in reality, very few cartels are

34. Cartels and Game Theory
Cartels tend to collapse due to three reasons:

35. 1. Cheating by cartel members
They promise to reduce production but when everyone else reduces production and the price of oil rises…….some cartel members can and will cheat to increase their profits

36. Logic of Cheating….. No Cartel
Countries
Output per Country
Output
Profit per Country (per day) 10
10 MBD
100 MBD
$360 million
World Output
World Price
$36

37. Logic of Cheating….. Cartel
Countries
Output per Country
Output
Profit per Country (per day) 10
8 MBD
80 MBD
$400 million
World Output
World Price
$50

38. Logic of Cheating….. Cartel with One Cheater
Countries
Output per Country
Output
Profit per Country (per day) 9
8 MBD
72 MBD
$380 million 1
10 MBD
$475 million
World Output
82 MBD
World Price
$47.50

39. 1. Cheating by cartel members
The logic is simple,
What happens when nine countries cheat and only one country keeps its promise?

40. Logic of Cheating….. Cartel with Nine Cheaters and One Non-Cheater
Countries
Output per Country
Output
Profit per Country (per day) 1
8 MBD
$300 million 9
10 MBD
90 MBD
$375 million
World Output
98 MBD
World Price
$37.50

41. 1. Cheating by cartel members
Cheating pays when other firms keep their promise and cheating pays when other firms cheat
When a monopolist increases quantity beyond the profit-maximizing quantity, the monopolist hurts itself

42. Saudi Arabia’s Strategies
The Payoff Table
Russia’s Strategies
Cooperate
Cheat
Saudi Arabia’s Strategies
($400, $400)
($200, $500)
($500, $200)
($300, $300)

43. Saudi Arabia’s Strategies
The Payoff Table
Russia’s Strategies
Cooperate
Cheat
Saudi Arabia’s Strategies
($400, $400)
($200, $500)
($500, $200)
($300, $300)
Dominant Strategy –

44. The Prisoner’s Dilemma
Ex:
Japan’s Strategies
Cooperate
Cheat
United States’ Strategies
($400, $400)
($200, $500)
($500, $200)
($300, $300)

45. 2. New entrants and demand response
High prices of a cartel will attract new entrants
These entrants do not feel bound by previous agreements
Cartels are more successful when there are fewer substitutes for the cartelized good – implies less elastic demand

46. 2. New entrants and demand response
With the ease of new entrants, it is easier to maintain a cartel in a natural resource than in a manufactured good

47. 2. New entrants and demand response
Natural resources are not the only “thing” in limited supply
A cartel may control access to some key inputs that cannot be easily duplicated
Ex.

48. 2. New entrants and demand response
NBA consists of 30 teams
Teams compete on the court but “collude” off the court
They use the NBA league structure to keep down player salaries – “salary cap”
If they do, face “the luxury tax”
Each team, when joining the NBA, agrees to limit how much spent on players
Example of a buyer’s cartel –

49. 3. Government prosecution
Cartels have been illegal since ____________
________________________
Governments don’t always prosecute cartels and sometimes even support them
Most cartels operate with clear legal and governmental backing
Examples:

50. 3. Government prosecution
Government-enforced monopolies and cartels are one of the most serious problems faxing poor nations such as Mexico, Russia, Indonesia and Africa
Entrepreneurs who start new businesses sometimes find that the law force them out of competition with the small number of so-called untouchable big men who have cartelized the major sectors of the government

51. 3. Government prosecution