Publisher's Synopsis
Excerpt from A Supergame-Theoretic Model of Business Cycles and Price Wars During Booms
This paper has two objectives. First it is an exploration of the way in which oligopolies behave over the business cycle. Second, it considers the possibility that this behaviour itself is a cause of business cycles and of sticky prices. We examine implicitly colluding oligopolies that attempt to sustain above competitive profits by the threat of reverting to competitive behavior to punish firms that do not cooperate. The basic point of the paper is that the oligopolists find implicit collusion of this kind more difficult when their demand is high. In other words when an industry faces a boom in its demand, chiseling away from the collusive level of output becomes more profitable for each individual firm and thus the oligopoly can only sustain a less collusive outcome. This suggests that when demand for goods produced by oligopolists is high, the economy produces an allocation which is closer to the competitive allocation and thus nearer the production possibility frontier. Insofar as the allocation in which the oligopoly acts collusively is inside the production possibility frontier, a shift in demand towards the oligopolistic sector can increase the output of all goods. The fact that the outputs of all goods tend to move together is, of course, the hallmark of business cycles. Thus we can interpret booms in aggregate economic activity as being due to a shift in demand towards the oligopolistic sectors and busts as shifts towards the competitive sectors.
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