Joint profit maximizing is where firms seek to coordinate prices, output and other variables to achieve maximum profit for the industry as a whole (they behave like monopolists). The equilibrium output in an imperfectly competitive market tends to exceed the monopoly level, also giving firms an incentive to restrict output.A good method of maintaining equilibrium is through the adoption of a ‘tit-for-tat’ strategy, where one firm may take the initiative to raise the price and lower the quantity produced which sends a signal to other firms in the market, if all firms follow suit they will earn monopoly profits instead of a share of oligopoly profits. It must however be made clear that any price cutter will be penalized by the leader by them also decreasing their price even if the other firm has since increased its price.
Axelrod4 proved that tit-for-tat, compared to all other strategies is robust strategy. A firm playing this strategy is never the first firm to defect, it only retaliates by punishing the deviant. It will then return to the cooperative strategy as soon as the punishment has occurred. The one apparent major flaw in this strategy would be that through punishing too quickly or too severely the firm may be misunderstood and other firms could interpret this action as an aggressive move. The initial deviant could also have been behaving in a manner with non-aggressive intentions i.e. in response to slack demand.
Misunderstanding can be avoided if firms played a strategy of tit-for-two-tats, where firms allow one unpunished defection. Therefore if a firms intentions were non aggressive, the period following the defection would see the firm returning to cooperative behaviour. This has the effect that the firm is not punished and that firm does not see its punishment as aggressive behaviour on the part of its competitor, it will not retaliate by also acting in an aggressive manner.Clearly this strategy is beneficial to all firms involved as it has the effect of maintaining high profits rather than accepting a cut in profits to punish its competitor. Defection may occur randomly, maybe through interventions by nature as the real world mimics a game of incomplete information. For example, the big three motor companies5 in the 70’s, where GM set the percentage price increases and Ford and Chrysler followed (this would follow the model of dominant firm price leadership).
Sometimes Ford and Chrysler would introduce new models before GM, so they would attempt to guess the price increase of GM and set theirs accordingly.If they guessed too high they would lower their prices, as they had to be seen to be competitive with the industry leader, but if they guessed too low, as they did in the years 1970 and 1974, they could have used the lower prices to gain market share at the expense of GM but instead acted ‘nicely’ and revised their price increases to levels similar to GM. This allowed price stability in the industry to be maintained.
As price competition can be destabilizing in oligopolies, firms often channel their competitive activities into activities such as advertising.A prisoner’s dilemma (how to remain at the perfectly collusive level when the incentive to cheat exists for each firm) may result from this with firms spending excessive amounts, but on the other hand it will also raise entry barriers and protect established firms’ positions. Advertising is underpinned by product differentiation (which also includes trademarks and copy writes, quality differences, design, packaging, credit terms, after sales services, location of store etc). Bain found that product differentiation was the most important entry barrier.New entrants will face higher costs than established firms, who may have to overcome consumer resistance and ‘shout louder’ to make them heard. A new firm will have to compete with all established firms previous advertising. New entrants must also take into consideration the learning effects which firms already established in the industry have experienced which will have allowed them to move down their average cost curves and produce at a rate unavailable to the new entrant. The question firms in oligopolistic markets face, is whether to compete or to collude.
If they choose to compete they must take into account rivals responses to their actions, so when deciding upon a change in price or output the oligopolist must consider expected changes that a rival will make to its price or output. Antitrust law says it is illegal to restrain trade or attempt to monopolize a market. The FT reported that in the year 2002 a total of one billion euros in fines were levied in the EU due to collusive practices. This is simply another incentive for firms to erect and attempt to maintain joint monopoly equilibrium without formal agreements.