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IAI Actuarial Core Principles · Business Economics · Profit maximisation under imperfect competition

Two Indian telecom firms repeat a pricing game indefinitely. Each adopts a trigger strategy: charge the high price until the rival undercuts, then charge the low price forever. Which statement about sustaining collusion is correct?

Collusion is more easily sustained when deviations are detected quickly and firms value future profits. Then the lost future profits from punishment outweigh the short-term gain from undercutting, so the cooperative high price is self-enforcing in the repeated game.

  1. ACollusion is more easily sustained when firms discount the future heavily
  2. BCollusion is more easily sustained when deviations are detected quickly and firms value future profitsCorrect
  3. CCollusion is impossible because the one-shot Nash equilibrium is low pricing
  4. DCollusion is sustained only if the number of firms is large
  5. Collusion depends only on the size of the one-period gain from cheating

Explanation

Collusion holds if the present value of future cooperation exceeds the one-time gain from cheating followed by punishment. Patience (a high discount factor) and quick detection raise the cost of cheating. Heavy discounting or slow detection weakens it, and repetition makes collusion possible despite the one-shot equilibrium.

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