The document discusses factors that influence the ability of firms to collude in markets. It finds that the ability of cartels to operate depends on the probability of a period occurring and the discount rate of future profits. The Folk Theorem states that for discount rates close to unity, many agreements that yield payoffs above the Nash equilibrium can be supported. Factors that help firms collude include: having a small number of firms, barriers to entry, frequent and regular orders, rapid market growth, similar technologies and costs, and product homogeneity.

1. Chapter 14. The Folk
Theorem

2. The Folk Theorem
• We have found the ability of cartels to operate
depends on the ratio p*R
• p= probability of a period occurring
• R= discount rate of future profits
• Folk Theorem: For discount rate close to unity, a
large number of agreements better than the Nash
equilibrium payoff can be supported as a SPNE
• i.e. firms existing for long periods of time and with low
discount rates for the future
• However, profits may not be large

3. Factors Influencing Collusion
• What factors determine the ability of firms to
collude in markets?
• Small number of firms
• Barriers to entry
• Frequent and regular orders
• Rapid market growth
• Technology and cost similarities
• Product homogeneity

4. Small Number of Firms
• Concentrated markets tend towards
better collusive agreements due to:
• 1) Easier communication and
strategizing among few firms
• 2) Higher share of collusive (monopoly)
profit
• Lower gains from one-period deviation
• 3) Firm survival more likely (higher p)

5. Entry Barriers
• Significant entry barriers help existing
firms keep control of the cartel
• If a new firm enters, one of two things
occur:
• 1) New firm competes with the cartel
• 2) monopoly profit must be shared with a
larger number of firms
• In either case, the result is a large
reduction in future monopoly profits and
increased chance of deviation

6. Frequent and Regular Orders
• Punishment of deviation requires
regular orders and profits
• If orders are far apart, deviator will
choose largest order and not receive
pushback for some time
• Cartel will face frequent deviation and
inability to agree on pricing

7. Rapid Market Growth
• Growing markets generate large
future profits
• This creates a disincentive to deviate
because the punishment in the future
is more harsh
• If a market is declining, firms may
want to deviate and grab existing
profits

8. Cost Symmetry and Product Homogeneity
• Similar cost structures allow for easy
setting of prices
• Low-cost firms more likely to deviate
• Product homogeneity also aids in
setting of prices
• OPEC has difficulty with cost
symmetry, as different countries have
a need for different prices
• Often to balance budget, not because of
cost differences