Effects of Demand Shock and its Volatility on Oligopolistic Pricing

Abstract

In this paper, I examine the eect of the degree of volatility as well as the eect of a positivedemand shock itself on an oligopolys pricing. Irst dene three measures of demand shockand measures of their volatilities. The data examined in this study support my hypothesisregarding the importance of the demand shock volatility in uencing implicit collusion inthe oligopolistic pricing behavior. Demand shock volatility actually yields a negative ect onthe price level of the implicit collusion. When the demand shock becomes more volatile, theloss incurred by deviation becomes smaller in the next period, while the prots from deviationbecome larger. In such a case, a singlerm is more likely to deviate from its implicit collusiveprice in this case. Therefore, the oligopoly lowers its collusion price tremendously so as toprevent he deviation of any individual rm. Also, the demand shock volatility inuences theeect of a positive demand shock, actually increasing the eect of a positive demand shock.The price level is decreased further to discourage a deviation of an individual rm, since asinglerm is more likely to want to deviate as the demand shock volatility increases. Therefore,the implicit collusion price should be much lower than the price on a positive demand shockwith less volatility.