The Cartel Game! Student Instructions

Cartels and Profit Maximization Q P A Cartel Tries to Move a Market from “Competition” towards “As if Controlled by a Monopolist” Competition As if Controlled by a Monopolist Pc D MC = AC S Qc Profit This is a slide copied from Modern Principles: Microeconoimcs 2nd edition PowerPoint Slides by Solina Lindahl. Since EconApps is a free product and used for education, using this slide should fall under fair-use in copyright law. However, you may want to substitute a similar graph according to the textbook you are using in class. Pm MR Qm

Your cartel is being watched! The class has been divided into four-firm industries that want to act as cartels The government wants to protect its consumers from greedy fat cats like you colluding on prices and output. The U.S. Department of Justice is watching you and ready to make an example out of you. Here is a video on the bust of a Lysine Cartel. To play it safe, your cartel agrees not to meet for the first couple of rounds and act as a non-collusive oligopoly. The current app does not tell the instructor who is in each group until you burn a round after pairing the group. This is part of the reason why you would need to start off with the cartel behaving as a non-collusive oligopoly. The video is a clip from “Fair Fight in the Market Place” streamed on YouTube.

Decision Screen Everyone starts with an output of 10. You decide your output reduction. Each unit reduced costs you $1 in profit but creates $2 profit for the cartel ($0.50 profit for you and for each of the 3 members) The highlighted column shows your possible earnings based on the decisions of others in the cartel (scroll to see more).

Decision Screen To move the tokens to the “My Output Reduction” box finger drag each token until you are satisfied with your decision. You can move tokens back and forth until you lock in your decision. Press and hold the “Done” token to lock in your decision.

WHAT IF? Analysis Touch the others’ average row to highlight. The red box is your round earnings IF you keep your current decision (5) AND IF the others’ group members send the average expected (7) to the “My Output Reduction” box.

Summary Screen After all decisions you see what others’ average actually is. The Industry’s Output Reduction is calculated. The total output reduction is multiplied by 2 and split evenly to get your equal share, which is added to your tokens kept = My Profit. The instructor can play a couple of rounds as a noncollusive oligopoly. Or the instructor can proceed to the next slide

To Collude or Not Collude? Let’s try a few rounds where you can meet with your cartel members and collude on an industry output reduction level. Option 1: Government legalized your cartel Option 2: Collusion is still illegal, but they are not watching you as often Professor will flip a coin twice for each group. If it’s heads twice then the cartel will have to act like a competitive industry and not reduce output the next round. The risk aspect associated with cartel collusion is optional. We currently do not have the feature of risk built into the game.

Discussion of the Cartel Game rounds Who reduced their output by the full amount? Why? Who did not reduce their output? Why? Who did something else? Did collusion help more? Were you willing to take the risk of colluding and getting caught?

Cartel Problems The Cartel Interest – reduce output and maximize cartel profits. Need coordination to form a collusive agreement, which is illegal in U.S. Need cooperation to uphold the collusive agreement Cartels are considered a public bad for customers because they face the same price markup they would receive from a monopoly.

Cartel Problems The Self-Interest – increase output and capture more market share Incentive to cheat on collusive agreement Incentive to increase output by a firm in cartel is greater than for a monopoly because the loss in revenue is split amongst the other cartel, so the net gain in revenue is greater Cheating cartel member makes more profits Retaliation and Cartel Breakdown Conditional Cooperation – You cheat, so will I! Cartel becomes a competitive oligopoly or breaks into a price war Good for customers and efficiency, bad for the cartel’s profits Cartels are considered a public bad for customers because they face the same price markup they would receive from a monopoly.

Other Things That Break Down Cartels: Decrease in Market Demand What if customers, in their long-run expectation of your cartel’s high prices found substitutes for your product or ways to conserve and decreased their overall demand. Now each output unit reduced will produce less industry profit for the cartel = $1.20. Incentive to cheat is greater because the opportunity cost of reducing output is $0.70 instead of $0.50.

Other Things That Break Down Cartels: New Entrants and Size of Cartel Profits attract the entry of new firms (who may or may not join the cartel) if barriers to entry are weak. What if the size of the cartel was increased such that the class only had two cartels instead of several. Each output unit reduced will produce the original industry profit for the cartel = $2, but this profit is divided among a larger number of firms. The current app does not tell the instructor who is in each group until you burn a round after pairing the group. You could have it such that a few of the group members are outside the cartel, meaning they don’t know who they can negotiate with.