Collusion

What is collusion?

It can take different forms:

• agree on sales price

• allocate quotas among themselves

• Divide markets

• Collusive practices allow firm to exert market power, artificially restrict competition and increase prices to reduce welfare

When is deviation from a collusive agreement less likely?

• When the market is small

• when sellers prices are observable

• when deviation is detectable

• when punishment is high

Folk Theorem

Freidman 1971 - When economic agents do not discount the future heavily in infinity horizons, firms can have any profit from 0 to the fully collusive profit

Factors affecting collusion

• V(D) down, future value of deviating - collusion more likely

• PI (D) down, today’s deviating profits - collusion more likely

• PI (C) up, today’s collusive profits - collusion more likely

• number of firms goes up, collusion less likely

• Future discount rate goes up, collusion less likely

• improved observability of competitor’s pricing facilitates collusion

• Lagged timing (like more periods before deviating from the cartel is revealed) makes collusion less likely

• Higher future demand, or demand growth - collusion more likely

• Symmetry among firms is a factor facilitating collusion

What is the critical discount point for collusion?

DISCOUNT POINT = (PI (D) - PI (C)) / (V(C) - V(D))

What is the implications of critical discount threshold?

When firms care more about the future, they are more likely to stick to the cartel!

Price Parallelism - Collusion

Price Parallelism is not necessarily evidence of collusion, so competition authorities should only act on hard evidence

What does competition authorities do re. collusion?

• prohibit unilateral communication of prices to be charged, unless to consumers

• Prohibit exchange of info about prices/quantities among competitors

• Prohibit firms’ attempts to introduce mechanisms which favour information exchanges

Product Differentiation - Collusion

When firms have different production costs that rise with quality, it is the price-cost margin that matters (affecting IC), so it can be higher or lower firms that chisel the cartel:

1. For small differences in unit production costs, low quality firms have more to gain from deviating (Bos and Marini 2019)

2. For high differences in unit production costs, high quality firms have more to gain from deviating (Häckner 1994)

Information Asymmetry and Collusion

Besanko and Spulber (1989) - pertinent point is that competition authorities cannot see firms’ cost functions

Besanko and Spulber (1989) - Characteristics

• identical firms and marginal cost pricing

• marginal cost is only known to firms.

• 2 types of firms (low and high cost which are random).

• Competition authorities incur audit cost C and charge fine F if collusion is identified

• Output is observable

Besanko and Spulber (1989) Proposition 1

It is never the case that low-cost firms behave competitively while high-cost firms collude - therefore, with asymmetric information, competition authority has to tolerate some low-cost collusion to economise on enforcement costs

Besanko and Spulber (1989) Proposition 2

Competition investigations must be launched when prices are higher - not necessarily because of collusion but to deter low-cost firms pretending to be high-cost for their own gain

Besanko and Spulber (1989) - Limiting Assumption

Assume that collusion is perfect and a competition authority cannot affect it’s sustainability, what about leniency/whistleblowing

Leniency Programmes

US since 1978, EU since 1996

Leniency Paper to Drop in

Aubert, Kovacic and Rey (2006) - competition between firms is not usually one-shot and colluding firms know they will be competing again in the future and are therefore reluctant to snitch in order to participate in collusion in the future

2 issues with leniency

1) Can cartels sustain themselves with leniency?

Chen and Rey (2013) - “collude and report”, adverse on welfare

2) How do cartels adjust their prices in response to leniency?

Hoube et al. (2015) - ex-post leniency, decrease in maximal collusive price!