The Theory of Collusion Under Financial Constraints

Abstract:     
This paper analyzes how financial constraints affect equilibrium payoffs and behaviors in repeated Cournot games. Modifying minmax and feasible payoffs, we derive the folk theorem under financial constraints. Our theorem illustrates that introducing financial constraints shrinks the set of equilibrium payoffs in favor of a firm that has a larger financial budget. We also show that financial constraints can substantially restrict possible equilibrium behaviors. For instance, collusion in which firms equally divide a monopoly profit in each period, which is often assumed in applications in industrial organization, may not be sustained in any equilibrium. Furthermore, playing the Cournot equilibrium in each period need not be an equilibrium, either.

Number of Pages in PDF File: 22

Keywords: collusion, financial constraint, folk theorem, repeated game

JEL Classification: C72, C73, D43, G33, L13

working papers series