Cartels as a Prisoner's Dilemma | Microeconomics by Game Theory 101

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In previous lectures, we have seen that a monopolist can extract more profits than a pair of firms under duopoly when those two firms act competitively. This raises the possibility that both would benefit by forming a cartel to cut production. However, this comes with its own problem: each firm is better off increasing its production beyond the cartel's recommended quantity if the other firm plays by the cartel's rules.

This lecture explores how the firms can resolve the problem using the shadow of the future. Under grim trigger strategies, the firms begin by cutting production. They then maintain that reduced level of production as long as each has played by the rules. But failure to comply leads the firms to switch to producing the competitive quantity. Some analysis reveals that the cartel is sustainable under these conditions as long as the firms are sufficiently patient.

For more on what a discount factor is conceptually, watch this lecture:    • Game Theory 101 (#55): Discount Factors  

For more on how to calculate an infinite stream of payoffs using a discount factor, watch this lecture:    • Game Theory 101 (#56): Geometric Seri...  

For some more nuance on how grim trigger works, watch this lecture:    • Game Theory 101 (#58): Grim Trigger i...  

0:00 Comparing Cournot Competition to Monopoly
1:16 The Benefits of Forming a Cartel
2:47 The Cartel Credibility Problem
4:17 Model Setup
6:33 Grim Trigger Strategies
8:28 Today's Payoff for Cheating
11:32 Punishment Payoff for Cheating
12:04 When Is the Cartel Sustainable?