3

Collusion and horizontal agreements

Dierent forms of collusive agreements: price xing allocation of production quotas market sharing Two types of collusion: Explicit collusion, where rms communicate and enter into explicit collusive agreements (e.g., cartels) Tacit collusion, where rms do not communicate but reach an "implicit understanding" that implies less competition Coordination problem! Any collusive agreement tacit or explicit always brings with it the temptation to deviate from it. The temptation to deviate implies that two factors are essential for collusion to arise: Detection of deviation Punishment of deviation A rm might not deviate from a collusive agreement if it knows that a deviation will be quickly detected and punished. Fundamental trade-o facing each rm that enters into a collusive agreement: The instantaneous prot gain of deviating from the collusive agreement must be weighed against the future expected prot loss once the punishment starts. 34

 In general: the less rms discount future prots, the easier it is to sustain a collusive agreement.

3.1

Factors that facilitate collusion

Market concentration: Collusion is more likely the smaller the number of rms in the industry The more rms, the larger the benets of deviating Fewer rms make coordination easier Entry: The easier it is for new rms to enter the industry, the harder it is to sustain a collusive agreement Collusive (high) prices make entry more attractive Cross-ownership: Coordination is easier Lower incentives to compete Regularity and frequency of orders The absence of extraordinary orders reduces the temptation to deviate High frequency of orders facilitates quick punishment in case of deviation Demand stability Increases the degree of observability in the market 35

 Easier to determine whether a drop in sales is due to demand uctuations or price-undercutting by rivals Symmetry: With symmetric players, it might be easier to coordinate on a collusive agreement that benets all rms Price transparency: Exchange of price/quantity information

3.2
3.2.1

Analysis of collusion in a supergame

A general model

Consider an industry where n rms play an innite horizon game If all rms choose a collusive action: c is current prots for rm i i Vic is the (discounted) present value of all future prots If rm i deviates from the collusive agreement: d is the current prot in the deviation period (before detection) i Vip is the (discounted) present value of all future prots (after detection) Assume that rms discount the future by a factor (0, 1) We can dene the discount factor as = 1 , 1+r

where r is the interest rate between two periods. 36

 Alternative interpretation of : can represent the uncertainty about when the game ends More precisely: can be represent the (constant) probability that the game will continue for one more period. Collusion is a Nash equilibrium only if each rm prefers to play the collusive action rather than to deviate from it Firm i has no incentive to deviate from the collusive action if c + Vic d + Vip , i i or d c (Vic Vip ) . i i The current prot gain from deviation must be lower than the discounted future losses resulting from the punishment. This condition holds if the discount factor is suciently high: i := d c i i , c Vi Vip

and the condition must hold for all i = 1, ..., n. In other words: sustaining collusion is possible only if the players are suciently patient 3.2.2 A specic model

Consider an industry where n identical rms play an innitely repeated game. The rms produce the same homogeneous good at the same unit cost c. 37

 Bertrand competition: In each period t, rms set prices simultaneously and non-cooperatively. All rms have the same discount factor If all rms set the same price p, then they share demand such that Di (p) = and D (p) n

(p) , n where (p) denotes aggregate prots when all rms set the price p. i (p) =

Any rm can capture all demand (and all industry prots) by charging a (slightly) lower price than the other rms. Consider the following trigger strategies: At t = 0, each rm sets the collusive price pm that maximises joint prots At each point in time t > 0, each rm sets the price pm if all rms have set the price pm in all previous periods. Otherwise, each rm sets p = c forever. These trigger strategies will constitute a Nash equilibrium with a collusive outcome pi = pm in each period if (pm ) 1 + + 2 + 3 + ... (pm ) + 0 + 2 + 3 + ... n Since
t=0

t =

1 , 1

the above inequality can be written as := 1 38 1 . n

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