Collusion and cooperative outcomes are most likely to occur
CHOICES
when firms are able to build trust by interacting repeatedly with each other.
as a result of a Nash equilibrium.
in monopolistic competition.
when there is a large number of firms competing in an industry.
in perfect competition.
The correct answer and explanation is:
Correct Answer: When firms are able to build trust by interacting repeatedly with each other.
Explanation:
Collusion and cooperative outcomes are most likely to occur when firms can build trust through repeated interactions, a concept rooted in game theory and industrial organization. In markets where firms compete repeatedly over time, they have the opportunity to develop strategies that foster cooperation, such as implicit agreements to restrict output or maintain higher prices, known as tacit collusion.
The rationale behind this behavior lies in the “repeated game” framework. If firms interact only once, their dominant strategy might be to compete aggressively, as seen in a standard Nash equilibrium of one-shot games. However, when interactions are repeated indefinitely or over a long time horizon, the prospect of future payoffs changes the strategic calculus. Firms can adopt strategies like “tit-for-tat,” where they cooperate as long as others do but retaliate if others deviate. This possibility of future retaliation acts as a deterrent against deviation and supports cooperative outcomes.
In industries with few firms (oligopolies), collusion is more feasible because monitoring and enforcing cooperative behavior are easier. For example, firms may observe market shares or pricing changes and respond accordingly. This contrasts with industries with many competitors (perfect competition or monopolistic competition), where the incentive to collude diminishes due to the difficulty of coordinating and monitoring behavior.
Collusion is generally not sustainable or relevant in perfect competition, as the large number of firms and homogeneous products force prices to equilibrium levels. Similarly, in monopolistic competition, product differentiation and the presence of many competitors undermine the incentives for collusion.
In summary, repeated interactions create a foundation for trust and cooperation among firms, as they can punish deviations in future periods. However, collusion often violates antitrust laws, as it reduces competition and harms consumers by leading to higher prices and reduced output.