Asian companies, including

produced

Lysine—dietary supplement that makes pigs, chickens and dogs grow faster.

input

animal feed

& 3 other

Lysine Conspiracy

Archer Daniels Midland

Four Types of Market Structure

Number of Firms

many few one

Type of Product

identical differentiated

Perfect Competition

Monopolistic Competition

Oligopoly Monopoly

(dowels) (funeral services)(lysine) (guano)

Imperfect Competition

Oligopoly: The Case of Lysine, 1994

Characteristics of Oligopoly

1) Small number of Sellers

2) Similar or identical products

3) Firms know one another—oscillate between being

incentive to cooperate and act like monopoly

incentive to cheat on one another

friends and foes

Lysine Cartel

Mark Whitacre, “boy wonder” president of lysine division

1992: Mark was embezzling new plant wasn’t working

Mark blamed it on sabotage

triggered FBI investigation

Mark turned Informant

Lysine Cartel

fixed costs of $15 million per year.(2) MC of producing lysine was $0.60 per

Assumptions: (1) Two firms had identical plants with

pound at all levels of output, i.e., plants were never operated close to capacity.

(3) Market demand for lysine in 1994 was:

P = 1.80 – Q1.80720

P($/lb)

Quantity (millions of lbs / year)

The Demand for Lysine, 1994

DMR

P = 1.80 – Q1.80720

P($/lb)

Quantity (millions of lbs / year)

$0.75

AFC ($)

Q (millions of lbs per yr)

20150

600

$0.60

AVC ($)

$1.35

ATC ($)

$0.60$0.60$0.10 $0.70

$0.025 $0.625

TFC Q

$15 million 20 million

= ——————

= $.75

Avg Costs for a Lysine PlantAFC (Q = 20 million) = ———

P($/lb)

Quantity (millions of lbs / year)

$0.75

AFC ($)

Q (millions of lbs per yr)

20150

600

$0.60

AVC ($)

$1.35

ATC ($)

$0.60$0.60$0.10 $0.70

$0.025 $0.625

TFC Q

$15 million 20 million

= ——————

= $.75

Avg Costs for a Lysine PlantAFC (Q = 20 million) = ———

What did the Lysine Cartel do?

(1) Fix Prices

(2) Set Quotas (Q) for 2 Firms

(3) Meetings & Phone ConversationsTo Monitor (and Haggle over) Quotas

Suppose

Fixed P = PM

Each Firm’s Quota

= QM12

P($/lb)

Quantity (millions of lbs / year)

PM

QM½QM

AT

C(½

QM

)

0.725

US Market for Lysine, 1994

MC=AVCATC

DMR

P($/lb)

Quantity (millions of lbs / year)

PM

QM½QM

AT

C(½

QM

)

A

B

0.725

TR=A+B= PM* ½ QM=$1.2*120=$144 million

TC=B=ATC* ½ QM=$0.725*120=$87 million

Econ π =A=TR−TC=$144-$87=$57 million

US Market for Lysine, 1994

MC=AVCATC

DMR

Abide Cheat

Abide

Cheat

$57 million

$57 million

Using Game Theory to Model the Lysine Cartel

Suppose ADM exceeds quota byΔQADM=30 million

Suppose Asian Lysine exceeds quota byΔQAsian Lysine=30 million

P($/lb)

Quantity (millions of lbs / year)

PM

QM Q1CQC=(½QM+30)=150

AT

C(Q

C)

A

B

TR=A+B= P1C* (½ QM+30) =$1.125*150=$168.75 million

TC=B=ATC*(½QM+30) =$0.7*150=$105 million

Econ π =A=TR−TC=$168.75-$105=$63.75 million

MC=AVCATC

DMR

One Cheater (1C): how does the cheater do?

P1C 1.125

Abide Cheat

Abide

Cheat

$57 million

$57 million

Using Game Theory to Model the Lysine Cartel

Suppose ADM exceeds quota byΔQADM=30 million

$63.75 million

Suppose Asian Lysine exceeds quota byΔQAsian Lysine=30 million

P($/lb)

Quantity (millions of lbs / year)

PM

QM Q1C½QM

AT

C(½

QM

)

A

B

TR=A+B= P1C* ½ QM =$1.125*120=$135 million

TC=B=ATC*(½QM)) =$0.725*120=$87 million

Econ π =A=TR−TC=$135-$87=$48 million

MC=AVCATC

DMR

One Cheater (1C): how does the non-cheater do?

P1C 1.125

0.725

Abide Cheat

Abide$57 million

$57 million

Using Game Theory to Model the Lysine Cartel

Suppose ADM exceeds quota byΔQADM=30 million

$63.75 million

$48 million

$63.75 million

$48 millionCheat

Suppose Asian Lysine exceeds quota byΔQAsian Lysine=30 million

P($/lb)

Quantity (millions of lbs / year)

PM

QM Q2CQC=½QM+30

A

B

TR=A+B= P2C* (½ QM+30)=$1.05*150=$157.5 million

TC=B=ATC*(½QM+30) =$0.7*150=$105 million

Econ π =A=TR−TC=$158-$105=$52.5 million

MC=AVCATC

DMR

Both Cheat (2C)

P2C 1.05

1

AT

C(Q

C)

Abide Cheat

Abide$57 million

$57 million

Using Game Theory to Model the Lysine Cartel

Suppose ADM exceeds quota byΔQADM=30 million

$63.75 million

$48 million

$63.75 million

$48 million $52.5 million

$52.5 million

Cheat

Suppose Asian Lysine exceeds quota byΔQAsian Lysine=30 million

If Chooses Best Choice BECAUSE

Abide Cheat $63.75 > $57

Cheat Cheat $52.5 > $48

Abide Cheat

Abide

Cheat

$57 $63.75

$57 $48

$48 $52.5

$63.75 $52.5

If Chooses Best Choice BECAUSE

Abide Cheat $63.75 > $57

Cheat Cheat $52.5 > $48

Abide Cheat

Abide

Cheat

$57 $63.75

$57 $48

$48 $52.5

$63.75 $52.5

has a dominant strategy because no matter what chooses to do, its best strategy is to cheat.

Since the payout matrix is symmetric, ’s dominant strategy is to cheat.

Abide Cheat

Abide$57 million

$57 million

$63.75 million

$48 million

$63.75 million

$48 million $52.5 million

$52.5 million

Incentives to Cheat on the Collusive Agreement

Cheat

Nash Equilibrium: no player has anything to gain by changing only its own strategy

Abide Cheat

Abide$57 million

$57 million

$63.75 million

$48 million

$63.75 million

$48 million $52.5 million

$52.5 million

Is This a Prisoners’ Dilemma?

Cheat

Yes

Cartel quota= 120

2 Firms

Cheaters= 30 extra

Would Society Like the Firms to Abide or Cheat? Abide Cheat

Abide

Cheat

$57 $63.75

$57 $48

$48 $52.5

$63.75 $52.5

P($/lb)

Quantity (millions of lbs / year)

QM Q2C Q*

MC=AVCATC

DMR

1.05P2C

PM

P($/lb)

Quantity (millions of lbs / year)

MC=AVCATC

DMR

1.05P2C

PM

Both CheatBoth Abide

QM Q2C Q*

DWL DWL

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

The Price of Lysine, 1990-1995

1990 1991 1992 1993 1994 1995

Enormous ADM plant 1st operates

1st Meeting of

Cartel in Mexico

City

Meetings in IL, Tokyo,

Vancouver, Paris & CA

FBI RaidsADM head-

quarters