Thursday, October 22, 2009

Cheating for a $20 - Freakonomics Blog -

If you're convinced that monopolies and oligopolies are everywhere, you should read this. It's a simple demonstration of how hard it is to maintain the type of collusion necessary for an oligopoly or a monopoly to survive. That is, unless you get it written into law. Put another way, sustainable monopoly & oligopoly requires government.

Each year in my 500-student principles class I gather a group of eight students and tell them that I will auction a $20 bill to the highest bidder. If two or more students bid the same thing, the difference between $20 and their joint bid will be divided among the winning bidders. They can collude to fix the price just like oligopolists who violate antitrust laws, but they must mark down their bids in secret.

Today seven of the students stuck to the collusive agreement, and each bid $.01. They figured they would split the $20 eight ways, netting $2.49 each. Ashley, bless her heart, broke the agreement, bid $0.05, and collected $19.95. The other 7 students booed her, but I got the class to join me in applauding her, as she was the only one who understood the game.

It showed that, even in a market like this one with very few players, collusion is difficult to maintain. There are tremendous incentives for one or more parties to cheat and move the market toward a competitive outcome. Unfortunately nobody has ever gone as high as the predicted equilibrium bid of $17.50.
Cheating for a $20 - Freakonomics Blog -