Oligopolistic Equilibrium and Financial Constraints

Abstract

We model a dynamic duopoly in which firms can potentially drive their rivals from the market. A consequence is that, for some ranges of parameters, the static Cournot equilibrium outcome cannot be sustained in an infinitely repeated setting. In those cases, there is a Markov perfect equilibrium in mixed strategies in which one firm will eventually be driven from the market with probability one. The presence of potential bankruptcy makes the set of outcomes supportable via tacit collusion different than in the absence of bankruptcy. We show that producer surplus in the maximum collusive outcome is greater under bankruptcy consideration, since the outcome maximizing joint profits is skewed in favor of more efficient firm. Our numerical simulations illuminate that consumer surplus and social welfare also increase in many cases, although those welfare effects are ambiguous in general.

Keywords: Financial Constraints, Bankruptcy, Firm Behavior, Dynamic Games

JEL Classification: D2, D4, L1, L2