Question

The Asian rice-exporting nations planned to discuss a proposal that they form a cartel. Ahead of the meeting, the countries said that the purpose of the rice cartel would be to contribute to ensuring food stability, not just in an individual country but also to address food shortages in the region and the world. The cartel will not hoard rice and raise prices when there are shortages. The Philippines says that it is a bad idea. It will create an oligopoly, and the cartel could price the grain out of reach for millions of people. Source: CNN, May 6,2008 a. Assuming the rice-exporting nations become a profit-maximizing colluding oligopoly, explain how they would influence the global market for rice and the world price of rice. b. Assuming the rice-exporting nations become a profit-maximizing colluding oligopoly, draw a graph to illustrate their influence on the global market for rice. c. Even in the absence of international antitrust laws, why might it be difficult for this cartel to successfully collude? Use the ideas of game theory to explain.

Short answer

A profit-maximizing colluding oligopoly would reduce output to increase prices, illustrated by a shift in the aggregate supply curve. Game theory suggests collusion is difficult due to incentives to cheat.

Step-by-step solution

Understanding the Question

Read the exercise carefully. It involves the formation of a rice-exporting cartel and its potential impact on the global market and prices. We are required to explain their influence, illustrate with a graph, and use game theory to analyze the difficulty of collusion.

Definition of a Profit-Maximizing Colluding Oligopoly

Define the concept of a profit-maximizing colluding oligopoly. A colluding oligopoly is a market situation where a few producers agree to set prices and output levels to maximize their joint profits, behaving like a monopolist.

Influence on Global Market and World Price

Explain how a profit-maximizing colluding oligopoly would influence the rice market. By reducing the total output of rice, these nations could increase the world price of rice. This higher price would maximize their collective profits at the expense of higher costs for consumers globally.

Graphical Representation

Draw a graph showing the influence on the global market. Plot the aggregate supply curve of the cartel, the global demand curve, and indicate the original price and quantity versus the cartel's reduced supply and increased price.

Discussing Collusion Difficulties Using Game Theory

Use the concepts of game theory to analyze the difficulties of collusion. Explain that each country has an incentive to cheat on the agreement to maximize individual profits while the others stick to the agreed output. This creates a 'prisoner's dilemma' situation where the incentive to defect is high.

Key concepts

Colluding Oligopoly

A colluding oligopoly happens when a small number of producers in a market agree to work together. They set prices and output levels to maximize their combined profits, much like a single monopoly. By agreeing on how much each can produce and at what price, they can jointly control the market.

Game Theory

Game theory is the study of strategic interactions where the outcome for each participant depends on the actions of all. It helps us understand competitive and cooperative behaviors in economics. In the context of a colluding oligopoly, game theory explains why sustaining collusion is challenging.
Each member of the cartel will have private incentives to cheat to increase their market share and profits. Yet, if all members cheat, the cartel’s ability to control prices collapses.

Supply and Demand Graph

To illustrate the impact of a colluding oligopoly on the global market for rice, let's use a supply and demand graph. On the vertical axis, we have the price of rice. On the horizontal axis, we have the quantity of rice.
The **global demand curve** slopes downward, indicating that as rice becomes cheaper, people buy more.
The **supply curve** of the cartel would be higher because the cartel would restrict output to increase prices. The result is a new equilibrium with a higher price and lower quantity compared to a competitive market.

Prisoner's Dilemma

The prisoner's dilemma in game theory shows why two rational individuals might not cooperate, even if it appears that cooperation is in their best interest.
Imagine two criminals are arrested and interrogated separately. Each has the option to betray the other or remain silent. Mutual cooperation (staying silent) yields the best joint outcome. However, each individual has an incentive to betray the other to minimize their personal sentence.
Similarly, in a colluding oligopoly, each nation has an incentive to cheat by selling more rice independently, hoping others adhere to the agreed restrictions. This pursuit of personal gain over joint gain can lead to the breakdown of the cartel.