Abstract
Non-cooperative game theory purports that economic agents behave with little regard towards the negative externalities they impose on each other. Such behaviors generally lead to inefficient outcomes where the social welfare is bounded away from its optimal value. However, in practice, self-interested individuals explore the possibility of circumventing such negative externalities by forming coalitions. What sort of coalitions should we expect to arise? How do they affect the social welfare?
We study these questions in the setting of Cournot markets, one of the most prevalent models of firm competition. Our model of coalition formation has two dynamic aspects. First, agents choose strategically how to update the current coalition partition. Furthermore, coalitions compete repeatedly between themselves trying to minimize their long-term regret. We prove tight bounds on the social welfare, which are significantly higher than that of the Nash equilibria of the original game. Furthermore, this improvement in performance is robust across different supply-demand curves and depends only on the size of the market.