Question

The Australian Government monitors the behaviour of oligopolies to ensure firms are not behaving anti-competitively. One behaviour they are concerned about is collusion. Design and analyse a payoff matrix to explain collusion. Do you think rational firms would collude? Why or why not? Explain the Nash equilibrium and resulting payoffs. Can the firms do better? Does behaviour in real-life differ from the theoretical prediction? What can be used to sustain collusion in the real world?

Feel free to copy/paste the below and fill in the blanks with example numbers:

Firm 1	Firm 2
		Collude	Compete
	Collude	( , )	( , )
	Compete	( , )	( , )

Answer 1

irm 1	Firm 2
	Collude	Compete
Collude	( 20, 20 )	(10 , 25)
Compete	(25 , 10 )	(15 ,15 )

The collusion often leads to a rise in the joint profit of firms. While the competition leads to a decline in the profits of firms, but chances of cheating are rampant following the formation of collusion.

If both firms collude, each profit is equal to the $ 20 while if one firm deviates from the collusion, the deviator profit will rise to the $ 25.

But here the deviation from the collusion would be an attractive option for both firms. Competing is the dominant strategy for both firms. Eventually, both will end up with a payoff of $ 15 each.

The Nash equilibrium leads to the under profits of firms. Thus these firms can improve their profits by entering into the collusion.

The written agreement would lead to the consolidation of the collusion. Further there must be appropriate mechanism to detect the potential defection from the agreed strategy.