The effects of oligopoly in the US Automobile sector on pricing and development

Table of contents

1. Introduction

2. The Price Leader in the Oligopoly

3. How Prices are determined
3.1. Influences on the Surpluses and Welfare

4. Absence of the Bertrand-Nash Equilibrium

5. Punishment in the Cartel

6. Product Introduction
6.1. Applied Game Theory

7. Conclusion

1. Introduction

The US automobile industry is a good example of an oligopoly. It consists mainly of three major firms, General Motors (GM), Ford, and Chrysler. The influence of this oligopoly can be seen in the prices and the development and introduction of new car models into the American car market. Extensive work has been done on the field of collusive behaviour in the US automobile market and moreover the introduction of the small car in the 1950s shows how the firms collude when it comes to the introduction of a new car.

This paper will show which firm is the price leader in the GM, Ford, and Chrysler oligopoly and explain how prices are determined, in this step there will be drawn a comparison between the surpluses and welfares in this oligopoly and a perfect competition. Then it will be analysed why there cannot be found a Bertrand-Nash Equilibrium. The oligopoly in the American automobile industry is collusive, because of that, it will after that be pointed out how price cheaters are punished in that cartel. Finally the underlying decisions of an introduction of a new car model will be examined and the game theory will be applied to that.

2. The Price Leader in the Oligopoly

In the oligopoly of the American automobile industry a vivid dynamic between price leaders and price followers can be found. Here the example of the pricing decisions between 1965 and 1971 shows strong evidence that General Motors is the price leader in this oligopoly (Boyle & Hogarty, 1975). In this time span Chrysler always announced its price increases first, after that General Motors announced a price increase which was smaller than Chrysler’s. General Motors’ move then led to Chrysler reducing its own price to be roughly the same as General Motors’ (Boyle & Hogarty, 1975). Boyle and Hogarty (1975) do not mention explicitly how Ford behaved in that pricing arrangement but it can be assumed that Ford is a price follower who in the end copies General Motors’ chosen price.

3. How Prices are determined

Now after having explained the relationships and the pricing behaviour in this cartel, the next step is to show how the amounts of the prices are chosen. It is clear that there is a difference between how prices are chosen in perfect competition markets and the oligopolistic market. In perfect competitions the market participants can maximise their profit by producing the quantity where the marginal costs of producing a unit is equal to the market price which itself is equal to the marginal revenue. This yields to the fact that the market is efficient and competitive because the market participant just charges the price where economic profit is zero. In contrast to that, the collusive companies of General Motors, Ford, and Chrysler are trying to avoid this competitiveness in the market by pricing jointly (Bresnahan, 1987). The oligopolists act like a single monopolist when it comes to pricing decisions and want to maximise the joint profit instead of the firm’s single profit (Bresnahan, 1987). This pricing decision leads to the result that the collusive price is way above the marginal costs at this quantity, so maximising the profit of the single companies to be as the maximised profit in the perfect competitive market (Bresnahan, 1987).

3.1. Influences on the Surpluses and Welfare

This collusive price setting behaviour leads, as usual in oligopolies or in this specific case of oligopolists acting like one single monopolist, to a loss in total welfare and in the consumer surplus. At the same time there is an increase in producer surplus because the price in the collusive oligopoly acts like a mark-up on the price-quantity equation of equalising marginal costs with marginal revenues. In figures, the collusive price generates a produce surplus of $4billion in each year, while the loss of the consumers is $7billion in each year (Bresnahan, 1981). The total loss in welfare is over $3billion in each year (Bresnahan, 1981). This figures show that there is a big loss in market efficiency after the introduction of the collusive price by the oligopolists.

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