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Culture Documents
Contents
1.
Definition ................................................................................................................................1
2.
2.1.1.
2.1.2.
2.1.3.
2.1.4.
2.2.
3.
2.2.1.
2.2.2.
2.2.3.
Conclusion............................................................................................................................ 10
1. Definition
In economics collusion is defined as the oligopolistic market situation where firms
may refrain from undercutting each others prices or from selling in each others market
areas, regions or other divisions, and thus prices are higher than in a competitive benchmark.1In his book Competition Policy: Theory & Practice, Motta argues that in order
for collusion to arise there must be two elements that characterize the involved parties.
First, all the participants firms in collusion must be able to detect in time that a colluding
firm is deviating through undercutting the agreed price, and second, the should be able
to imply a punishment, i.e. either, selling higher quantities in the post-deviation period,
or setting even lower prices, in order to impede the deviant firm from gaining profits. 2 If
these two conditions exist, a collusive outcome will arise among the firms in a market.
2. Types of Collusion
As far as the coordination is concerned, collusion can be achieved in two ways: it
can either be overt (explicit) or tacit (implicit). Each type is analyzed below.
2.1.
Overt Collusion
The term explicit or overt collusion refers to formal agreements among firms, with
firms meeting often to discuss about prices and possible punishment in a case a colluding firm deviates. These agreements are officially called cartels. Cartel agreements may
provide for setting the least prices, limiting the output or capacity, restricting non-price
competition or posing measures to restrict entry to the market.3 Cartels are usually
banned under antitrust laws in modern economies. In the US they are banned under the
Sherman Act (Section 8.1) and in the EU under Article 81 & 82 of the EC Treaty.4 They
theoretically split into: a) the direct profit-maximization ones (which are formed simultaneously or subsequently) and b) the market-sharing agreements. In order to express
better a formalized analysis, we use the Cournot oligopolistic model.
Oxford Dictionary of Economics, J. Black, N. Hashimzade & G. Myles, Oxford University Press (2012),
lemma: Collusion
2
Competition Policy: Theory and Practice, M. Motta, Cambridge University Press 2004, Ch. 4, p. 140
3
Oxford Dictionary of Economics, J. Black, N. Hashimzade & G. Myles, Oxford University Press (2012),
lemma: Cartels
4
The Political Economy of Antitrust, Ghosal, V., Stennek, J. (Eds.), Elsevier B.V., Ch. 8, pp. 217
In a Cournot game of
, where
is the total
quantity produced by all firms), it can be proved that a firm is best response is to produce
. (1)5.
our math, we suppose that not all firms are going to participate in the cartel, so the independent firms are
with
), the profits for each firm outside the cartel in Cournot equilibrium will be
. Since the cartel may be considered as one firm, the whole cartel in
Cournot equilibrium will gain
member should have an incentive to leave the cartel agreement, which is equivalent to
(2), or meaning that for a firm the profits should be bigger inside
the cartel than outside. Solving inequality (2) will lead to
(3).
It is seen from (3) that for
which implies
which means that every member has incentive to leave the agreement. Yet, the inequality shows that for
tel agreement, but no oligopoly with 3 or more firms can attain such an agreement.6
Firms outside the cartel perceive the higher cartel price as a public good, so they have a
strong free-riding incentive on it. But we should recall that this analysis is based on the
5
6
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.3, p. 54-59
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 337-338
prerequisite that firms are cost-symmetric and produce a homogeneous product, which
both are simpler hypotheses. (for differentiated products in a market, see 7)
2.1.2. Sequential cartel formation
, with the profits each firms gains when all the firms are independ(Its 1, and not 0, according to the previous model we had used with
ent,
) If
is the first
integer larger than the RHS of the inequality, denoting the firms forming the cartel, then
the first
, which
roughly means that the least lucrative size of a cartel is larger than 80% of the firms in
the industry.8
2.1.3. Network of market-sharing agreements
Using
again the same hypotheses ( firms, Cournot competition on homogeneous product, demand
7
8
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 338-339
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 340-341
distinct geographical markets, we can see that the profit of a firm (principally on market , but profiting in market j, too) are:
the firms active in market . Reasonably, the first term denotes the
profit within the domestic market, and the second term in within the foreign market,
having signed no agreement yet. If an agreement is signed between a firm and a firm ,
that is a link
while
the
incentive
to
sign
]
an
is
where the first term in carets denotes the less competition on s market, and the second
term subtracted is the former access to s market, which is now lost. (2 opposite effects)
The difference above refers to the incentive of a firm to sign an agreement with another firm . But the incentive in case the network is empty or non-empty, in the
sense that no firms in the market may have signed any sharing agreement, or not.
In an empty network, symbolized by
which is true
, which because of symmetry, is always sat, which roughly means that if a non-empty net-
work is formed, it must be of complete collusion with every firm being a monopolist on
its own market.9
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 341-343
OPEC
2.2.
Tacit Collusion
Since cartels are banned by competition law in most of the countries of the developed or quickly developing economies, a typical conversation about collusive coordination should focus on tacit or implicit collusion, which occurs without explicit communication between the colluding parties. Since it is risky for modern firms to sign explicit agreements on setting higher than competitive prices, which would give antitrust
authorities proof for penalties14, they do not cooperate but they agree on prices or
quantities of product observing each others moves in the market. By game theory, it can
10
http://europa.eu/rapid/press-release_IP-01-1625_en.htm?locale=en
Oxford Dictionary of Economics, J. Black, N. Hashimzade & G. Myles, Oxford University Press (2012),
lemma: Organization of Petroleum Exporting Countries
12
http://history.state.gov/milestones/1969-1976/OPEC
13
Foreign Commerce and the Antitrust Laws, W.L.Fugate, Aspen Publishers, 2002, p. 192
14
Competition Policy: Theory and Practice, M. Motta, Cambridge University Press 2004, Ch. 4, p. 138
11
be verified that tacit collusion is not possible when the horizon of the competition in the
game is finite ( periods), since they would know ex-ante their profits in their last period
of the game. (for the analysis, see15)
But in an infinite horizon (
game in the same market) tacit collusion may emerge at the subgame perfect equilibrium. For simplicity, we consider two firms,
grim trigger strategy, according to which firm initially chooses the action that maximizes both firms profits, acting in a cooperative behaviour. (We will later see that the action may be setting either the price or the quantity of the product). Firm can follow that
action, and then firm
will keep choosing the same action as long as both of them have done so in the previous
periods, marking thus a cooperation phase. Nevertheless, in case one of the two firms
chooses another action and thus deviates, that new action will trigger the beginning of
the so-called punishment phase. From that period on and infinitely both firms choose the
action that leads to the Nash equilibrium of the game, thus competing again.
The profits in each different phase are defined as follows: when the firms are in the
cooperation (or collusion) phase, each one gains a profit
, where
is the mo-
nopolistic profit, since both firms collude, thus acting as the sole firm in the market.
When one firm acts cooperative and the other deviates, the latter gains
mally is equal or to
, which nor-
(or a little lower), while the cooperative firm normally gains ze-
16
ro profits . During the punishment phase or, equally, at the Nash equilibrium of the static competitive game, both firms gain
.A
firm always maximizing its profit will compare what it immediately gains from deviation with future losses because of the punishment phase that will follow, which depends
both on the magnitude of each type of profit and on the firms discount factor.
If we start in a punishment (or non-cooperative) phase, firm
according to the Nash equilibrium of the static game for the whole infinite horizon, and
15
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 344
The Economic Assessment of Mergers under European Competition Law, D. Gore, S. Lewis, A. Lofaro,
F. Dethmers, Cambridge University Press 2013, p. 334
16
firm s best reaction is to do so, too, at every period, that it is following the trigger
strategy. But if we start in a cooperative phase, and firm chooses the grim trigger strategy, it will gain
gain
that tacit collusion will be sustainable, if the discount factor of the firms is above a certain level. Hence, firms will mostly collude if they fear that deviation is paying less now
and that they will lose more in the future through punishment than now through sharing
profits, provided that deviation is observable by the firms so that punishment can start.17
But, the actions a firm can undertake may be either price-setting or quantity-setting.
And so is the way that the theoretical model above can be applied as.
2.2.1. Bertrand price competition
For simplicity, we have to recall the Bertrand model of competition with constant
for two firms. If a same price is set by firms, thus the market will split equally
for both firms. If firms set the monopoly price
one will gain
even if they could charge a range of lower prices up to the competitive one). By slightly
undercutting the rivals price, a firm will mostly gain a deviation short-term profit almost
17
, since the customers have no incentive to buy anymore the product from
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 345-346
the firm with the higher price, and thus, the betrayed firm gets 0 profits. After the deviation, the punishment period begins, when each firm will eventually set the Nash equilibrium price
So, in this price-setting duopoly of infinite horizon, any collusive profit level between
and
firms, with
remaining equal to
. We can gener-
, but
. So, using
, which
is increasing for n, that is, when there are more firms in the market, the discount factor
has to be greater and thus collusion is more difficult to sustain.18
2.2.2. Cournot quantity competition
But firms can also adjust their quantity to their competitors choices, rather than setting prices. We suppose a homogeneous product market of
game, where
this
in
the
function
will
give
us
the
. Sub-
monopoly
profit:
. (1)
However, we already know that at the Nash equilibrium of this symmetric game a firms
best response is to produce
. (2) Since also
))
the firm may deviate if it considers that all the other firms are producing q, maximizing
the previous profit for
18
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 346-347
quantity
(3). From
.
and is increasing with
when
, which as in the
Bertrand price competition means that collusion will be sustainable for more firms if the
discount factor is even greater, which means difficult sustainability of collusion. We can
notice that for
of collusion since
, there is
In 1984, 40 wood pulp producers, which had their offices outside the EU were found
out by the European Commission to have infringed Article 81 (it was then named A.85)
through price collusion. The EC based its claims on suspicious parallel behavior among
firms, consisting of quarterly price announcements, simultaneous price announcements
and eventually same prices. The EC had then imposed large fines on the producers. 20 In
1993, the European Court of Justice was called by the same producers to reinvestigate
the case, since they claimed that they were established outside the EU and thus could not
be considered to infringe the EU competition law. The ECJ had difficulty in establishing
a clear decision, since there was indeed missing evident documentation or agreements
that would leave no doubts for the formation of a cartel. In the light of the experts reports that conducted the new investigation, the ECJ reached the conclusion that cooperation is not the only possible reason for parallel behavior, but still supported the ECs decision, claiming that it was of high importance that these suspicious practices were undertaken within the territories of the EU, no matter where the firms were established.21
19
Industrial Organization, Market & Strategies, P. Belleflamme & M. Peitz, Ch.14, p. 346-347
Competition Policy in the EU, X. Vives, Oxford University Press 2009, Ch. 5 (M. Motta), p.111
21
Competition Policy in the EU, X. Vives, Oxford University Press 2009, Ch. 5 (M. Motta), p.112-113
20
2.2.3.2.
Samsung & LG
In 2012, the KFTC (regulatory authority for competition in S. Korea) fined Samsung
Electronics and LG Electronics for coordination on fixing prices of some electronic appliances during 2008-2009, holding secret meetings. Samsung was fined 18.86 million,
while LG was fined 13.75 million.22
3. Conclusion
Either overt or tacit, collusion damages consumers by leading the prices of products
to rise more than normally. Below, the graph shows how consumers are damaged from
i.e. the formation of a cartel in a duopoly comparing to the competitive benchmark:
curve
and
for each
. Provided that each firm has different costs, the profit of firm 1
to (
the effects of this example of collusion are the same as those of a normal monopoly.23
Collusion is obviously leading to negative effects for consumers. Especially tacit collusion, which is more difficult to be detected, can lead to absorbing much of the consumers surplus for long periods, since no intervention of competition authorities in time
may be possible.
22
23
http://www.bbc.co.uk/news/business-16540678
http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=collusion
10