Question

In 1961 in a Philadelphia court, several of the nation's most prestigious manufacturers (including GE, Westinghouse, Carrier and Allen Chalmers) were found guilty of price fixing in the electrical equipment market (transformers, switch gear, insulators, etc.) market.

a. Using game theory define a "Nash equilibrium". They describe the three models of oligopolistic behavior defined in the course, Cournot, Stackelberg, and Bertrand. How is each different from and similar to the two other models? And what market outcomes do they predict.

b. Use the Bertrand Model to explain why equipment manufacturers selling (almost) identical products at well-publicized prices might end up with the same prices and therefore appear to be fixing prices when in fact they are competing aggressively.

Answer 1

1.Nash Equilibrium can be defined as a stable state of a decision making system (game) where players(firms, individuals) can not increase their payoff by unilaterally changing the strategy given all other participants keep their strategies unchanged.

In Cournot competition, the firms compete on output levels to undercut their competitors assuming they won't change the production quantity, Its a simultaneous technique. The firms can maximize their profits at Cournot equilibrium (the point where all the best reaction curves of all the firms intersect) and can't deviate from this price as the best reaction curve of other firms will wipe out their profits. ( tradeoff between lower sales or lower price).

In Stackelberg model, One firm is dominant and competition is based on quantity. This model is sequential and the other firms simply follow the leader based on its production. Leader has biggest market share than its competitors due to its pole position in deciding output and price.

In Bertrand model, the fight is based on price rather than output, the firms compete on prices due to similar Marginal cost. This kind of model is mostly seen in standardized production industries like the example provided. Due to same MC, firms get the idea of capturing the bigger market share only by underpricing. This led to the Bertrand equilibrium where the firms are selling goods at the Marginal Cost value and profit is miniscule.

2. In standardized equipments like switch gears, transformers, the marginal cost of production is generally same for all producers and the products vary only slightly and in terms of superficial aspects like color. In such a scenario where products have very low degree of differentiability, the producers can only compete on price which leads to decline in the price at the levels of MC. This kind of arrangement appears like a collusion while the firms are not colluding but rather competing aggresively for large share of market by reducing the prices.