Analyzing Market Concentration, Game Theory, and Collusion
HHI (Herfindahl-Hirschman Index) – Cautions
Industries with higher C4 tend to have higher HHI. However, there are exceptions:
- For example, the motor vehicle industry may be more concentrated than the snack food industry based on C4, but the snack food industry might show a higher HHI.
- C4 is based on the market shares of only the four largest firms in an industry and does not account for the fifth-largest firm.
- In global markets, C4 and HHI do not account for the entry of foreign firms, which can overstate the true level of concentration in industries with significant foreign producers.
- For example, the brewery industry, where the top 4 firms account for 90% of industry sales, ignores producers in Mexico, Canada, Europe, Australia, and Asia.
Industry definitions and product classes also affect these indexes. Considerable aggregation across product classes can occur when constructing indexes. For example, the soft drinks industry might have a C4 of 52%, which seems low. However, Coca-Cola and Pepsi dominate the market for cola drinks, and the concentration ratio is based on a more broadly defined notion of soft drinks.
Entry Barriers
Common entry barriers include:
- Capital requirements
- Government protection
- Patents
- Economies of scale
One-Shot Simultaneous Game – Setting Prices
Profits for both firms are higher when they both charge high prices than when they both charge low prices. However, if one firm charges a high price and the other undercuts it, the lower-priced firm gains all the other firm’s customers and earns higher profits at the expense of the competitor. Nash equilibrium: charge low prices. Firm A is always better off charging the low price regardless of what firm B does, and vice versa. Profits are 0, which is less than the firms would earn if they colluded and “agreed” to both charge high prices.
Simultaneous One-Shot Prices, Promotion, Marketing
Each player makes moves without knowledge of the other players’ decisions. For example, two gas stations where products are perfect substitutes.
Advertising increases the demand for a firm’s product by taking customers away from other firms in the industry. For example, two companies compete against each other, and products will become obsolete. The question is whether to advertise or not. Nash equilibrium and dominant strategy: advertise.
Choosing a Standard to Solve the Coordination Problem
Not all firms have competing interests. For example, producers of electrical appliances have a choice of which type of electrical outlets to put on appliances: 90-volt, four-prong outlets or 120-volt, two-prong outlets.
- It is inconvenient for consumers to wire their houses.
- Two standards would adversely affect the profits of appliance manufacturers.
- Coordination can ensure higher profits.
How the decision is reached:
- Meeting and agreeing
- Standard set by the government
- No incentive to cheat on the agreement
Employee Surveillance
Managers want workers to work hard, while workers enjoy leisure. A solution is random “spot” checks. Game theory explains its rationale.
- The manager has two options: to monitor or not to monitor.
- The worker has two options: to work or not to work (shirk).
There is no Nash equilibrium. If the manager decides to monitor, the worker’s best strategy is to work.
Deciding in Infinite Games – Factors Affecting Collusion
- Number of firms: Collusion is easier when there are fewer firms. For example, with 5 firms, the total number of monitors needed is 20, and the cost of monitoring rivals reduces the gains to colluding.
- Firm size
- History of the game
- Punishment mechanisms
Finitely Repeated Games – Resignation and Quits
When a worker announces that she or he plans to quit, say tomorrow, the cost of shirking to the worker is low, and the threat of being fired has no bite. The manager can fire the worker as soon as he/she announces the plan to quit (legal restrictions). The best strategy for a worker is to wait and tell at the end of the day. A better solution is to provide some rewards, e.g., a letter of recommendation, connections with other employers.