Assignment: Equilibrium, Welfare and Information

Part A:

Read the following articles and answer the questions below:

"Auto parts price-fixing probe rattles industry" by Eric Tucker. Associated Press.

"Cartels: Just one more fix", The Economist.

(Both articles have some information about the recent cartels that have been uncovered in worldwide markets for various auto parts, but you are welcome (and encouraged) to look for additional articles on the internet if you feel like you need more information on these industries or the cartels themselves. Remember, of course, that if you borrow or paraphrase specific facts or opinions from any of these articles you should cite them and provide a reference to the article at the end of your answers.)

Note: In the markets discussed here parts manufacturers are the sellers and automobile manufacturers are the buyers. Individual car buyers do not actually participate in these markets, but they may be affected indirectly if collusion by parts manufacturers raises costs for automobile manufacturers which will likely force them to charge more for cars.

1. Identify the important "facilitating factors" or characteristics of the industry that may have made collusion easier or more likely in auto parts markets, and briefly explain why each these characteristics might facilitate collusion in this setting. Identify as many potential factors as you can and give careful explanations for why they are relevant in these auto parts markets and why they might make collusion easier (or harder) to sustain. Where appropriate, try to utilize the related economic concepts and terminology we have discussed in class.

2. Over the last few decades there has been a steady increase in the number of cartels that have been discovered and successfully prosecuted. What important changes have led to increased detection and also to more successful prosecution?

Part B:

3. Suppose two firms compete in an industry with an inverse demand function given by P = 200 - 2Q . Each firm has a marginal cost of $40.

a. Solve for the monopoly profits, quantity, and price.

b. Solve for the Cournot Nash Equilibrium. State the quantities and profits for each firm and the market price.

c. Suppose firm 2 produced ½ of the joint profit maximizing output (i.e., colluded) and firm 1 cheated. What would be firm 1's one-period profit maximizing output be? What is the resulting market price?

d. What would firm 1's profits be under this scenario (in part c)?

e. Suppose these firms compete repeatedly, such that the end of the game is unknown. At the end of each year, the probability the firms will compete against each other again is given as .6 and they discount future profits at a rate of .8. What is the present discounted value of expected profits if both firms collude in each period?

f. Suppose firm 1 believes that firm 2 has adopted a "grim trigger strategy" in which they will produce half the joint profit maximizing output if firm 1 always does the same, but if firm 1 ever produces more then firm 2 will punish by producing the Cournot equilibrium output level forever after. What is the present discounted value of profits for firm 1 if they decide to cheat in the first period.

g. Can the firms sustain collusion in equilibrium?