Two sellers operating in an oligopoly market enter into a collusion agreement to reduce output and raise prices. According to the Nash equilibrium, the agreement will be followed by A. Both firms B. Neither firms C. One of the firms The answer should be neither, right? Also, what is the difference between first, second, third degree price discrimination?
in oligopoly if one firm reduces while the other doesn’t, the first-mover gets the advantage. if there are only two sellers, and we assume price elasticity of demand I would go for A.
If there are more than two sellers in the oligopoly and they don’t have significant market share/pricing power, neither would reduce prices as they would lose out to their competitors.
First degree = charge each individual customer so their consumer surplus = 0 (squeeze every last drop of value, but hard to know what each customer would pay) Second degree = provide different quality versions of a product for a range of prices (think windows Pro vs home), the idea here is to sacrifice a little bit of that consumer surplus (the consumer would retain more surplus than under 1st degree) to benefit from lower costs of effectively getting the consumer to reveal the value they place on the product Third degree… not quite sure tbh! It is defined as separating consumers by demographics or traits…
what was the correct answer?
Yes, you are right, answer is B.
First degree price discrimination is the monopoly’s power to perfectly discriminate the price he charges on the same item to different users (consumer surplus eroded away)
Second degree price discrimination talks about the monopolist ability to charge different prices based on the order of each consumer. Those with higher order gets discount (lower price) which is not available to others.
Third degree is about offering better pricing to some level of consumers so as to segregate them into clusters.
Nice explained, burberryjam.
still don’t know if it is A or B? care to weigh in?
I also doubt. If they meet their agreement, A would be a correct answer but what if both would decide to cheat another?
hmm i would say the wording of entering into a collusion suggests they won’t cheat each other (and I’ve not seen any situation involving oligopolists reneging on contracts in any questions / CFAI material)
So its A then
Correct, both parties will tend to maximize profits in collusion with each other. In case of cheating one side will get more profit.
A is wrong, Nash equilibrium is that they will both cheat and no one will honour the agreement… The correct answer is B.
This may come in handy…
https://www.economics.utoronto.ca/osborne/2x3/tutorial/COLLFRM.HTM
The reason is simply that a collusive outcome is not a Nash equilibrium! Given the output of one of the firms, the other firm can increase its profit by choosing an output different from its collusive output.
The correct answer was A. This was on the CFAI official mock. The explanation stated was that both firms would maximum JOINT profit by abiding by the agreement. That is true - but it is not a Nash equilibrium! Nash equilibrium states that both parties would pursue the strategy that is best for THEM - and thus, both should cheat. Thanks everyone for your answers. Degree of price discrimination is not covered anywhere in Schweser.
Obviously, it is not a Nash equilibrium… A mistake on the part of CFAI…
can we assume they would do better for themselves by cheating?
if party A cheats and lowers price, party B will just follow suit immediately.
then, it comes down to elasticities to determine if a lower price overall will benefit them both… in the absence of more information I am comfortable in assuming neither cheats, and this still fits in with the Nash equilibrium.
They will not benefit but I am not sure that collusion is a part of Nash equilibrium. Therefore one party would take action solely to benefit itself without considering common interest. If only one cheats it will earn more, if both cheat they both earn less.
If B assumes A will honor the agreement, they are better off cheating. If they assue that A will cheat, they are also better off cheating. A nash equilibrium is where (given their assumptions about the other partys’ choice) each player has no incentive to defect from their own choice.
Both holding to the agreement can;t be a Nash Equilibrium, because each player has an incentive to cheat.
Thxs for clarfying, Kamerad.