Patrick Rey

Universit Toulouse I Toulouse, France

On the Use of
Economic Analysis Cartel Detection

European University Institute

Robert Schuman Centre for Advanced Studies
2006 EU Competition Law and Policy Workshop/Proceedings

To be published in the following volume:

Claus-Dieter Ehlermann and Isabela Atanasiu (eds.),
European Competition Law Annual 2006:
Enforcement of Prohibition of Cartels,
Hart Publishing, Oxford/Portland, Oregon (in preparation).
Please do not quote or circulate without permission
Patrick Rey. All rights reserved.

EUI-RSCAS/EU Competition 2006 Proceedings

On the Use of Economic Analysis in Cartel Detection

by Patrick Rey1

A.

Introduction

In principle, various economic approaches are available to detect cartels. For example,
following the structure-conduct-performance paradigm, a structural approach could seek to
identify the industry characteristics that make the industry prone to collusion; a conduct
approach could look at behavioural patterns that are more likely to be associated with
collusion than with competition; and a performance approach could, for example, look for
supra-competitive profitability. These approaches can be useful, particularly in contexts, such
as merger control, where the spotlight is already placed on a given industry and competition
agencies must figure out whether collusion is likely to be there. However, these methods are
costly to adopt in a routine way to detect collusion, in the absence of warnings already
attracting attention to a particular case. Moreover, at this stage, these approaches do not
provide robust, clear-cut answers. Overall, while further theoretical and empirical research is
probably warranted in this area, it is still difficult to use these approaches in a systematic way.
Yet economic analysis can also be used in a different way. By nature, cartels cannot
depend on binding, legally enforceable contracts; they must therefore rely on some form of
self-enforcement. This can make cartels fragile, and economic analysis can help to identify
the critical factors that may exacerbate this fragility and induce cartel participants to come
forward and report their activity. To put it another way, playing firms against each other
might make it possible to move from a police patrol to a fire alarm mode of operation, to
use the terminology of McCubbins and Schwartz:2 rather than sending out police patrols in
the street and looking for evidence of trouble, it may be better to try to induce those engaged
in illegal activity at least some of them to denounce it. This approach can also contribute
to deterring the formation of new cartels.
This paper is organized as follows. First, I briefly review the structural factors that
may facilitate collusion, which may be used to identify candidates for further investigation.
Then, I discuss the factual evidence that might be further indicative of collusion, before
presenting some of the conclusions from recent developments in the economics literature on
leniency and whistleblowing programmes.

Professor of economics, University of Toulouse, Ecole Polytechnique and Institut Universitaire de France.
See McCubbins M. and Schwartz T. (1984): Congressional Oversight Overlooked: Police Patrols vs Fire
Alarms, 28 American Journal of Political Science 165.
2

Patrick Rey

1/11

EUI-RSCAS/EU Competition 2006 Proceedings

B.

Structural factors3

The economic literature on collusion4 has identified several factors that may facilitate
collusion.
First, there are some basic structural variables,5 such as:
- Low number of competitors: the larger the number of parties involved, the more
difficult coordination becomes;6 and as the number of firms increases, each firm gets a
smaller share of the pie generated by collusion, which makes deviation more tempting
(short-run gains from deviation increase, while the long-run benefit of maintained
collusion is reduced).7
- High entry barriers: in the absence of entry barriers, any attempt to maintain supracompetitive prices would trigger market entry (e.g., short-term or hit-and-run entry
strategies), and this would erode the profitability of collusion;8 moreover, the prospect
of future entry tends to reduce the scope for retaliation.
- Frequent interaction between the firms: firms can more easily sustain collusion when
they interact more frequently, since they can then react more quickly to deviations.
- Market transparency: quick retaliation when one firm undercuts the others requires
such deviation to be identified by the other participants; as a result, collusion is more
difficult to sustain when individual behaviour is not readily observable and cannot
easily be inferred from available market data.9
3

This discussion borrows from the IDEI report for DG Comp, The economics of tacit collusion, available at
http://ec.europa.eu/comm/competition/mergers/review/the_economics_of_tacit_collusion_en.pdf. For a general
overview of the economics literature on collusion, see Motta M. (2004): Competition Policy: Theory and
Practice, Cambridge University Press.
4
The economic literature focuses mainly on tacit collusion, which, in contrast to typical unlawful cartels, lacks
explicit coordination mechanisms or information exchanges. However, explicit cartels and tacit collusion share
many common features, since in both cases firms must have proper incentives to implement the collusive
agreement. Therefore, the insights of the literature on tacit collusion, which rely on the analysis of selfenforcement, apply as well to explicit collusion.
5
While the literature often relies on conceptual analyses, there are also some empirical studies on tacit collusion,
following the initial work of Posner R. (1970): A Statistical Study of Antitrust Enforcement, 13 Journal of
Law and Economics 365, and of Hay G. and Kelley D. (1974): An Empirical Survey of Price Fixing
Conspiracies, 17 Journal of Law and Economics 13. These studies are surveyed by Levenstein M. and Suslow
V. (2004): What Determines Cartel Success?, Working Paper, University of Michigan, who emphasize their
disparity. However, they provide support for the importance of some of the structural factors discussed here
(such as the number of firms, entry barriers, and market stability). Symeonidis G. (In Which Industries Is
Collusion More Likely? Evidence from the UK, 51 Journal of Industrial Economics 45 (2003)) uses a natural
experiment (the adoption of the 1956 Restrictive Trade Practices Act) to identify the industries subject to pricefixing agreements in the 1950s. His analysis suggests that collusion is more likely the higher the degree of
capital intensity, and that it is less likely in advertising-intensive industries than in low-advertising industries. He
also finds a non-monotonic relationship between market growth and the likelihood of collusion (moderate
growth makes collusion more likely, while rapid growth makes it less likely). However, he finds no clear link
between concentration and the incidence of collusion.
6 See for example Compte O. and Jehiel P. (2002): Multi-Party Negotiations, mimeo, CERAS.
7 This insight is valid when holding all other factors constant. However, the number of firms is endogenous and
reflects other structural factors, such as barriers to entry and product differentiation.
8
However, John Sutton has stressed the possibility of durable situations where the profits from high prices
would simply be dissipated through inefficient duplication of fixed costs and an excessive number of market
participants.
9 This issue was first highlighted by Stiglers classic paper, A Theory of Oligopoly, 72 Journal of Political
Economy 44 (1964). Since then, it has been formally analyzed by Green E. and Porter R. (1984): NonCooperative Collusion under Imperfect Price Information, 52 Econometrica 87, and Abreu D., Pearce D. and
Stachetti E. (1985): Optimal Cartel Equilibria With Imperfect Monitoring, 39 Journal of Economic Theory

Patrick Rey

2/11

EUI-RSCAS/EU Competition 2006 Proceedings

Second, there are characteristics of the demand side:

Market growth: collusion is easier to sustain when short-term gains from a deviation
are small compared with the cost of future retaliation; thus, for a fixed number of
market participants, collusion is easier to sustain in growing markets, where todays
profits are small compared with those of tomorrow.10
Absence of significant fluctuations or business cycles: collusion is less sustainable in
markets that are subject to demand fluctuations (see FTC v. Arch Coal),11 since peak
periods exacerbate short-term gains from a deviation, relative to the potential cost of
later retaliation.12 Hence, demand fluctuations hinder collusion, particularly when
fluctuations are deterministic (as in the case of seasonal cycles, where it is anticipated
that the future will be less rosy) as opposed to random.
Demand elasticity: elasticity of demand has no clear impact on the sustainability of
collusive prices, but collusion is more profitable when demand elasticity is low, which
in turn can influence the firms willingness to establish a cartel and facilitate its
implementation despite the risk of being caught by antitrust authorities. Similarly,
collusion is a greater concern for consumers when demand is inelastic, both because
there is more scope for large price increases and because consumers are hurt more by a
given price increase when they have few alternatives.13
Buying power: even a perfect cartel may find it difficult to impose high prices on
powerful buyers, which makes cartel activity less profitable and, by the same token,
more fragile.14
The absence of club and network effects: club effects (that is, when consumers benefit
from being in the same club: using the same software, typing on the same type of
keyboard, subscribing to the same operator, and so forth.) tilt the market in favour of a
single participant, thereby creating a winner take all type of competition which is not
prone to collusion. In addition, club effects create lock-in effects that reinforce the
position of the market leader and thus increase the benefits derived from such a
position.
Finally, there are characteristics related to the supply side:
Mature industries with stabilized technologies: by allowing one firm to gain a
significant advantage over its rivals, innovation limits the scope for collusion; the
prospect of innovation reduces the value of future collusion as well as the cost from
possible retaliation from these rivals.

251. It may be noted that market stability can contribute to enhancing market transparency, since inferring
deviations from collusive conduct is easier and requires less detailed information when the market is stable. See
Khn K. (2001): Fighting Collusion by Regulating Communication between Firms, 32 Economic Policy 169,
discussing the role of information exchanges in this context.
10
This conclusion appears somewhat at odds with some court cases and opinions. Indeed demand growth is in
practice often interpreted as a factor hindering collusion. One possible reason for this apparent discrepancy is
that the above reasoning assumes that the number of market participants remains fixed despite market growth
(due for example to regulations or limited access to key inputs or technologies), while in practice, entry may be
easier in growing markets. See, e.g., Case T-102/96 Gencor v Commission[1999] ECR II-753.
11
329 F. Supp. 2d 109 (D.D.C. 2004), appeal dismissed per curiam.
12
See Rotenberg J. and Saloner G. (1986): A Supergame-Theoretic Model of Business Cycles and Price Wars
during Booms, 76 American Economic Review 390; Haltiwanger J. and Harrington J. (1991): The Impact of
Cyclical Demand Movements on Collusive Behavior, 22 RAND Journal of Economics 89.
13
Thus, the less elastic the demand the greater the potential harm to consumers. However, the impact on total
welfare is more ambiguous, since price increases generate less distortion when demand is inelastic. See, e.g.,
Tirole J. (1988): The Theory of Industrial Organization, MIT Press, Cambridge Massachusets, for a discussion
of this issue.
14
See Snyder C. (1996): A Dynamic Theory of Countervailing Power, 27 RAND Journal of Economics 747,
noting that large buyers can design procurement schemes that reduce the scope for collusion.

Patrick Rey

3/11

EUI-RSCAS/EU Competition 2006 Proceedings

Symmetric costs: it is easier to collude with equals.15 First, cost asymmetry,16 for
example, may make it difficult to agree on a common pricing policy, since firms with
a lower marginal cost will insist on lower prices than what high-cost firms would wish
to sustain; more generally, different cost structures may rule out focal points and
may exacerbate coordination problems. Second, technical efficiency would require
allocating market share to low-cost firms, which might be difficult to achieve in the
absence of side-transfers.17 Third, low-cost firms may be more tempted to deviate
from a cartel agreement, both because they may gain more from undercutting their
rivals and because they have less to fear from a possible retaliation by high-cost
firms.18
Symmetric capacities: an asymmetric distribution of production capacities hinders
collusion; the firm with the largest capacity has more incentive to undercut its rivals,
particularly if their production capacities limit their retaliatory power.19
Product homogeneity: a firm with a better product is in a situation similar to that of a
firm with lower costs, i.e., it has more to gain from cheating on the cartel (or, put
another way, it may favour a different net price, adjusted for the quality differential),
and has less to fear from retaliation;20 in addition, product differentiation may
contribute to reducing market transparency.21
Multi-market contact: firms can more easily sustain collusion when they are present
on several markets.22 First, multi-market contact may make firms interact more
frequently and allow them to maintain a cartel in markets where industry
characteristics would otherwise prevent them from doing so. Second, multi-market
contact may soften asymmetries arising in individual markets for example, one firm

15

This intuition may also explain the informal discussions about the role of so-called mavericks. A maverick
firm can be interpreted as a firm with a drastically different cost structure (or a drastic difference in any other
relevant dimension), which is thus unwilling to participate in or stick to collusive action.
16
See Bain J. (1948): Output Quotas in Imperfect Cartels, 62 Quarterly Journal of Economics 617 for an early
discussion.
17
However, side-transfers need not be monetary. For a discussion of these issues, see Osborne M. and Pitchik C.
(1983): Price Competition in a Capacity-Constrained Duopoly, 38 Journal of Economic Theory 238;
Schmalensee R. (1987): Competitive Advantage and Collusive Optima, 5 International Journal of Industrial
Organization 351.
18
See Harrington J. (1989): Collusion Among Asymmetric Firms: The Case of Different Discount Factors, 7
International Journal of Industrial Organization 289; Thalm J. (2005): Optimal Collusion under Cost
Asymmetry, mimeo, University of Toulouse. See also Mason C., Phillips O. and Nowell C. (1992): Duopoly
Behavior in Asymmetric Markets: An Experimental Evaluation, 74 Review of Economics and Statistics 662,
noting that, in experimental duopoly games, cooperation is more likely when players face symmetric production
costs.
19
See Lambson V. (1987): Optimal Penal Codes in Price-Setting Supergames with Capacity Constraints, 54
Review of Economic Studies 385; Lambson V. (1996): Some Results on Optimal Penal Codes in Asymmetric
Bertrand Supergames, 62 Journal of Economic Theory 444; Davidson C. and Deneckere R. (1984): Horizontal
Mergers and Collusive Behavior, 2 International Journal of Industrial Organization 117; Davidson C. and
Deneckere R. (1990): Excess Capacity and Collusion, 31 International Economic Review 521.
20
See, e.g., Ross T. (1992): Cartel Stability and Product Differentiation, 10 International Journal of Industrial
Organization 1; Martin S. (1993): Endogenous Firm Efficiency in a Cournot Principal-Agent Model, 59
Journal of Economic Theory 445.
21
See Raith M. (1996): Product Differentiation, Uncertainty and the Stability of Collusion, London School of
Economics-STICERD Discussion Paper Series EI/16:49.
22
The classic reference is Bernheim B. and Whinston M. (1990): Is Everything Neutral?, 96 Journal of
Political Economy 308. See also Parker W. and Rller L.-H. (1997) Collusive Conduct in Duopolies:
Multimarket Contact and Cross-Ownership in the Mobile Telephone Industry," 28 RAND Journal of Economics
304, and Evans W. and Kessides N. (1994) Living by the Golden Rule: Multimarket Contact in the U.S.
Airline Industry, 109 Quarterly Journal of Economics 341.

Patrick Rey

4/11

EUI-RSCAS/EU Competition 2006 Proceedings

may have a competitive advantage in one market and its rival may have its own
competitive advantage in another market; while a (single) market-level analysis may
then suggest that collusion is difficult to sustain, multi-market contact in such a case
restores an overall symmetry that facilitates collusion. International cartels such as the
vitamins cartel provide good examples of such multi-market contacts.
- Structural links: structural links can facilitate collusion among firms. For example,
cross-shareholdings reduce the gains derived from undercutting the other firm. Joint
venture agreements may further enlarge the scope for retaliation because a
participating firm can a deviating partner by, e.g., investing less in the venture.23 For
these reasons, collusion is more likely to emerge in markets where competitors are tied
through structural links.
- Cooperative and other contractual agreements: even in the absence of structural links,
simple cooperative agreements can contribute to foster collusion. As in the case of
joint ventures, these cooperative agreements can for example enlarge the scope for
retaliation, thereby enhancing the ability to punish deviating partners. This may be
particularly relevant for industries such as the telecommunications industry, where
competitors need to reach interconnection agreements in order to offer widespread
connectivity. These agreements not only enlarge the scope for retaliation, they also
have a direct impact on the operators pricing strategies.24 More generally, firms may
alter their contractual agreements, either between themselves or with third parties, so
as to facilitate collusion.25
This brief overview suffices to show that many factors may affect the scope for
collusion. Most often, a given market will have some characteristics that facilitate collusion,
and others that tend to hinder collusion. Predicting the likelihood of collusion on this bases
alone is thus a complex question.26
In addition, while these factors may help to identify those markets in which collusion
might be attractive or feasible, they cannot be relied upon to determine whether firms are
actually colluding.27 In the context of merger control, where the merger control office must
evaluate ex ante the future evolution of the industry, short of determining whether collusion
will indeed occur, a highly difficult if not impossible task, the merger control office can
review these factors to assess whether collusion will become easier to sustain.28 In an ex post

23

For a detailed analysis, see Martin S. (1995): R&D Joint Ventures and Tacit Product Market Collusion, 24
European Journal of Political Economy 357.
24
For example, telecoms operators that compete in linear prices could give each other incentives to maintain
high prices, even in the absence of repeated interaction, by agreeing on a high reciprocal access charge see,
e.g., Armstrong M. (1998): Network Interconnection in Telecommunications, 108 The Economic Journal 545;
Laffont J., Rey P. and Tirole J. (1998): Network Competition: I. Overview and Nondiscriminatory Pricing, 29
RAND Journal of Economics 1.
25
Marketing agreements can be employed to that effect. Jullien B. and Rey P. (Resale Price Maintenance and
Collusion, working paper, University of Toulouse, 2002) show, for example, that producers of consumer goods
can resort to Resale Price Maintenance to impose more uniform prices across local retail markets, thereby
making it easier to detect deviations from a collusive price. Record companies have been accused of marketing
their offerings according to simple pricing grids (with only a few categories, instead of personalized prices for
each author or title) for a similar purpose.
26
Moreover, the interplay of the factors may be important, as illustrated by the effects of market growth and
entry barriers. If entry barriers are so large that entry is highly unlikely to occur, market growth fosters collusion;
if instead entry barriers are moderate, market growth may stimulate entry, which in turn impedes collusion.
27
Formally speaking, the same market situation can give rise to different equilibria. In particular, firms may well
compete in each period as if it were the last one, even if another equilibrium exists in which they maintain
monopoly prices in each and every period.
28
While many factors appear relevant when evaluating the impact of a merger on collusion, some may be more
important than others. First, whenever there are no entry barriers, or where firms interact rather infrequently, or

Patrick Rey

5/11

EUI-RSCAS/EU Competition 2006 Proceedings

antitrust context, these factors may be looked at to determine whether collusion is a plausible
concern, but their analysis will not suffice to establish the existence of actual cartel activity.
An analysis of the history of the industry might help to answer that question.

C.

Factual evidence and behavioural patterns

Two types of factual evidence might be relevant to identify collusion: first, since the object or
effect of collusion is to impede competition, antitrust authorities could look at signs of supracompetitive prices or profits; alternatively, they can look for behavioural patterns that are
more likely to be associated with collusion than with competition. I briefly discuss these two
types of evidence.

1.

Supra-competitive performance

This approach relies on a comparison between the actual performance of the industry and the
performance that one would expect from normal competition in a comparable industry. This
requires reasonably good access to reliable price or accounting data, but it is also necessary to
have an idea of what the comparable competitive levels would be. The latter issue is clearly a
tough one, and it requires detailed data and analysis of costs and demand conditions (not only
in the current situation but in the supposedly competitive one as well). This exercise is all the
more difficult to realize in concentrated industries, which will often be subject to imperfect
competition anyway (that is, even a purely static, non-cooperative form of normal
competition would still yield significant price-cost margins and profits). More generally, this
type of in-depth study requires deep knowledge and expertise about the industry, and it is
more naturally associated with regulatory supervision than with the antitrust oversight.
One can also rely upon econometric methods when sufficiently rich data are available.
This approach can, for example, provide an estimate of the likelihood of collusion. However,
it is sensitive to various modelling assumptions and specifications with respect to the demand
and supply side.29 Recently however, the development of structural models of oligopolistic
models using panel data have made predictions possible even in the absence of precise
information on costs: in essence, sufficiently detailed data on prices and quantities enable
econometricians to estimate both demand and cost parameters. This opens up new scope for
application. Furthermore, this approach allows one to distinguish supra-competitive mark-ups
from normal but imperfectly competitive ones.30

the industry is primarily driven by innovation, collusion is unlikely to constitute a significant concern. A second
series of factors, such as the number of market participants, the degree of symmetry among those participants,
and the existence of contractual or other types of arrangements, are all relevant and likely to be directly affected
by mergers. The other factors (market transparency, product homogeneity, demand trend and fluctuations, multimarket contact, and so forth) may be relevant when the previous factors do not suffice to send a clear signal.
29
For example, using the same dataset, Porter R. (On the Incidence and Duration of Price Wars, 23 Journal of
Industrial Economics 415 (1985)) and Ellison G. (Theories of Cartel Stability and the Joint Executive
Committee, 25 RANd Journal of Economics 37 (1994)) reach different conclusions about the likelihood of
different collusive schemes adopted by an 1880s US railroad cartel.
30
For example, Nevo A.s analysis of the US ready-to-eat cereal industry (see Mergers with Differentiated
Products: The Case of the Ready-to-Eat Cereal Industry, 31 RAND Journal of Economics 395 (2000);
Measuring Market Power in the Ready-to-Eat Cereal Industry, 69 Econometrica 307 (2001)) suggests that

Patrick Rey

6/11

EUI-RSCAS/EU Competition 2006 Proceedings

This approach can thus be useful in determining whether collusion is likely or not in a
given industry. However, it is time- and resource-consuming (data collection, to begin with,
can be a real issue). In addition, this approach cannot yield certainty: by their nature,
econometric methods rely on probabilities; they can provide an estimate of the likelihood of
collusion, as well as confidence intervals, but they cannot produce definite yes/no answers.

2.

Collusive patterns

Alternatively, one can look for behavioural patterns that are more naturally linked to collusion
than to competition. The usual suspects include price parallelism and stable market shares.
Concerns have also been raised by a lack of price response to changing demand conditions.
Courts have been reluctant to take such patterns as evidence of collusion. In my view,
this reluctance is justified and may even extend to interpreting these patterns as signals, if not
proof of collusion, since such patterns can be consistent with competitive as well as collusive
behaviour. Therefore, in the absence of any further empirical investigation, one cannot
conclude that the industry has been, in fact, colluding. Three examples can illustrate that
point.
2.1.

Price parallelism

Consider first a benchmark situation where all competitors offer the same, homogeneous
product. In those circumstances, by nature and whatever the effectiveness of competition, the
prices of all active firms will necessarily be always equal, since any price above the others
would attract no customer. All these prices are therefore deemed to move together: one should
expect a perfect parallelism in the evolution of prices, irrespective of whether firms are
colluding or competing head to head against each other. This case is admittedly an extreme
one, but by continuity the reasoning extends to situations where firms have similar offerings.
The more similar the firms offerings, the narrower the price range that one should expect,
regardless of whether firms collude or compete.
But parallelism can also obtain in industries with significant product differentiation.
To see this, let us use the simplest model of oligopolistic competition, the so-called linear
model, where both costs and demand are supposed to have a simple, linear shape.31 In this
simple model, whatever the nature of the strategic interaction (in prices la Bertrand or in
quantities la Cournot) and whatever the degree of product differentiation, prices are the
same across firms, whether they compete or perfectly collude. Thus, here again one should
expect as much parallelism with competition as with collusion. To explore the issue further,
one can introduce some asymmetry on either the cost or the demand side. Doing so breaks
down the equality of the various firms collusive prices as well as of their competitive prices,
but it does not eliminate the scope for price parallelism. To see this, suppose for example that

mark-ups as high as 45% are more likely to be due more to product differentiation (making consumers willing to
pay for their favourite brand) and multi-branding (giving firms an incentive to maintain high prices on each
brand, to avoid cannibalizing their other brands) rather than to collusion. Similarly, the analysis of Pinkse J. and .
Slade M. (Mergers, Brand Competition, and the Price of a Pint, 48 European Economic Review 617 (2004))
suggests that the margins observed in the UK brewing industry result from intrinsically imperfect competition
(due for the main part to product differentiation, and for the remaining part to local concentration).
31
That is, firms have a constant unit cost and face a demand of the form qi = di ai pi + j aij pj , where d i
reflects the size of the demand and the as parameters reflect the sensitivity of the demand with respect to the
various prices.

Patrick Rey

7/11

EUI-RSCAS/EU Competition 2006 Proceedings

there are two firms 1 and 2 with different unit costs, c1 < c2, and that the demand for each
product i is of the form qi = d (pi -spj)/(1 s), where pi and pj denote respectively the price
of that firm and the rivals price; d is a demand scale parameter; and s is a parameter
reflecting the degree of substitution between the products.32 It can be checked that, whereas,
under competitive conditions, the prices of the two firms differ from each other (the firm with
a lower cost charging a lower price), they both respond in the same way to a change in the
demand parameter d.33 And while collusive price would also evolve in a parallel fashion, the
price range is actually larger for collusive prices than for competitive prices.34 Thus, in the
context of this simple example, a narrow range would be more a signal of competition than of
collusion. A similar analysis could be conducted for alternative forms of asymmetries, or for a
larger number of firms, at the cost of notational (and computational) complexity.35 The
bottom line is that, while the level of prices might be used to determine whether firms are
competing or colluding (provided that the observer has enough information on cost and
demand conditions), the fact that they evolve in parallel does not, by itself, allow for such
identification.
2.2.

Market share stability

There again, however, this feature does not by itself make it possible to distinguish collusion
from competition, since market share stability can be consistent with competition as well as
collusion. To see this in a simple way, it suffices to consider any situation where firms face
symmetric supply and demand conditions. Firms would then have the same market share,
both in the most profitable collusive outcome and in the competitive one, whatever the scale
of demand. A shift in demand thus has no impact on the firms relative market shares.
This example is of course extreme, and in practice asymmetry in the firms ability to
compete will generally yield asymmetric market shares. Yet this does not imply that market
shares would fluctuate when there is a general shift in demand, nor does it imply that market
shares should be fluctuating more in the case of competition than in the case of collusion.
While asymmetry in the firms technological ability, for example, leads in general to
asymmetric market shares, one would expect this to be the case with collusion as well as with
competition. And it may even be the case that market shares are more stable or diverge less
with competition than with collusion.
To illustrate these points, we can turn again to the linear model presented above,
where the demand depends on a scale parameter d and on the degree of substitutability
between the products, measured by s, and where two firms have different unit costs, c1 < c2.
In this very simple model, the difference in output levels is entirely driven by the price
differential; and whether firms compete or perfectly collude, this price differential depends on
the cost differential c2 c1 and on the degree of substitutability s, but it is unaffected by a shift
in the demand parameter d. Thus, while output levels are different (the firm with the lower

That is, the products are perfect substitutes when s = 1 and completely differentiated when s = 0.
A decrease in d by 1 unit induces the same decrease in both firms prices, equal to (1-s)/(2-s). In the polar case
of perfect substitutes (product homogeneity, s = 1), prices do not adjust to demand changes and are instead
entirely driven by costs.
34
The price range is (c2 c1)/2 in the case of collusion and is smaller and equal to (c2 c1)/(2 + s) in the case of
competition.
35
For example, if the demand for one product exhibits a constant elasticity with respect to the price of that
product, competitive prices are driven solely by (cost levels and) the value of the elasticity. Thus, as long as
demand fluctuations affect the market size but not the demand elasticity, competitive prices would remain
constant an extreme form of parallelism. In contrast, collusive prices would respond to changes in market
sizes. Thus, in that case competitive prices would actually be more parallel than collusive ones.
32
33

Patrick Rey

8/11

EUI-RSCAS/EU Competition 2006 Proceedings

cost having a higher output and thus a higher market share than the other), the difference
between the output levels remains constant over time in spite of changes in the demand
parameter d, whether firms compete or collude.36 This in turn implies that the difference in
market shares is smaller under competitive conditions than in the case of collusion, since the
output differential is the same and total output is larger with competition. In addition, a
declining shift in demand increases the market share differential under both competition and
collusion, but the adjustment is smaller in the case of competition.37 Thus, in the light of this
simple example, a small adjustment of market shares when demand is declining should be
interpreted as a sign of competition rather than collusion.
2.3.

Price reaction to changing demand conditions

Collusion concerns are sometimes raised when prices do not appear to react sufficiently to
changes in the environment, such as shocks to demand. However, even colluding firms would
have an incentive to revise their coordinated behaviour in reaction to changing demand
conditions. Furthermore, there is no clear reason suggesting that the optimal adaptation of
prices would systematically involve smaller price reductions under collusion than under
competition. It could actually be argued that, as competitive prices are driven more by cost
considerations, they might respond even less than competitive ones to changes in demand.
Accordingly, a small change in prices should be interpreted as a sign of competition rather
than collusion.
On the magnitude of competitive price responses to changes in demand. Generally speaking,
the outcome of non-collusive competition among a limited number of competitors is primarily
driven by the level of their (marginal) costs of production and by the cross-elasticity of
demand for each firms product. For example, consider the benchmark situation in which
firms produce the same homogeneous product at the same constant unit cost. The competitive
price then simply reflects the level of the unit cost, and is entirely insensitive to demand
shocks. Thus, in this utmost competitive situation, prices would not change when demand
falls.
Consider now another situation, where firms still have constant unit costs but offer
differentiated products. Competition is admittedly less intense in that case, so that competitive
prices reflect both cost and demand conditions. Suppose further that, for each firm, the
demand for its products exhibits a constant elasticity with respect to that firms prices.38 In
that case, the normal competition among the firms yields prices that depend on this constant
elasticity and not, for example, on the scale of the demand. Thus, as long as shifts in demand
have no impact on the own-elasticity of demand for one firms products with respect to its
own price, the competitive price levels remain unchanged.
Do collusive prices adjust less than competitive prices to changes in demand? As already
hinted, competitive prices tend to be driven more by cost considerations, and thus less by

The output differential is given by (1+s)(c2 c1)/(2+s)(1 s) in the case of competition and by (1+s)(c2
c1)/2(1 s) in the case of perfect collusion. In both cases, an increase in, say, the degree of substitutability s has a
qualitatively similar impact on (namely here, it induces an increase in) both output differentials.
37
The market share differential is given by (1+s)(2 s)(c2 c1)/(2+s)(1 s)2(d c1 +c2)/2) in the case of
competition and by (1+s)(c2 c1)/(1 s)2(d c1 +c2)/2) in the case of perfect collusion. The impact of a
reduction in the demand scale parameter d on the market share differential is thus (2 s)/(2+s) (< 1) smaller
with competition than with collusion.
38
That is, the demand for firm is products is of the form qi = Qi(p-i)pi -, where p-i represents the other firms
prices.
36

Patrick Rey

9/11

EUI-RSCAS/EU Competition 2006 Proceedings

demand considerations, than collusive or monopolistic prices. To see this, let us again use the
simple linear model of oligopolistic competition already presented above. In this simple
model, whatever the nature of competition (in prices la Bertrand or in quantities la
Cournot) and whatever the degree of product homogeneity or differentiation:
both the competitive and the collusive price level can be expressed as a
weighted average of the demand size parameter and of the unit costs; and
the weight put on the demand parameter is larger, not smaller, in the case of
perfect collusion.39
In the light of this simple illustration, a supposedly small change in prices should be
interpreted as a sign of competition rather than of collusion. Furthermore, as already
discussed in the previous section, downwards shifts in demand or demand fluctuations tend to
make collusion more difficult to sustain, particularly when demand is low or falling.40 It
follows that collusive prices then exhibit even larger adjustments to changes in demand
conditions, since firms cannot sustain as much collusion in bad times as they can in good
times.
However, as emphasized above, none of these features (i.e., price parallelism, stable
market shares, lack of price response to changing demand conditions) allows an outside
observer to distinguish collusion from competition. They are all consistent with competition
as well as with collusion. Furthermore, while this paper has addressed each feature in turn for
the sake of exposition, it should be clear at this point that a combination of the three features
is also consistent with competition as well as with collusion.
More recently, some work has been done to explore new and promising ideas, in order
to identify specific behavioural patters that are more likely to be indicative of collusion than
competition. For example, Joseph Harrington has stressed the role of sudden changes in
behaviour. One the one hand, the establishment of a cartel would be expected to lead to rapid
price increases, while occasional collusion break-downs might lead to temporary price wars;
cartels will seek to avoid sending signals that are too obvious, which might lead them to adapt
prices more slowly.41 One might expect a cat-and-mouse situation, where colluding firms try
to avoid adopting precisely the type of pattern that one would normally associate with cartels.
This would lead to revised expectations about cartel behaviour, and so on and so forth.
The issue is further complicated by the fact that many cartels probably operate in a
less than fully effective way, which multiplies the number of possible patterns. Overall, while
further research in this area is probably warranted, at the moment it appears difficult to rely
solely on this approach to detect cartels.

39

In the simplest case, where two firms produce homogeneous goods and the market demand then takes the
simple form Q = d p, the perfectly collusive price (i.e., the monopoly level) puts equal weights on the demand
and cost parameters (pm = (d + c )/2), whereas the competitive price just reflects the unit cost in the case of price
competition la Bertrand (pB = c), and puts on the demand parameter a weight that is half of that put on cost in
the case of quantity competition la Cournot (pC = (d + 2c )/3). In the latter case, the difference between the
two weights furthermore increases with the number of firms. For example, in the case of five firms, the ratio
between the two weights becomes 1 to 5: pC = (d + 5c)/6.
40
See, e.g., Rotemberg J. and Saloner G. (1986): A Supergame-Theoretic Model of Business Cycles and Price
Wars during Booms, 76 American Economic Review 390, or Haltiwanger J. and Harrington J. (1991): The
Impact of Cyclical Demand Movements on Collusive Behavior, 22 RAND Journal of Economics 89.
41
See Harrington J. and Chen J., Cartel Pricing Dynamics with Cost Variability and Endogenous Buyer
Detection, International Journal of Industrial Organization (forthcoming). In the same vein, it has been argued
that, once a cartel has been successfully prosecuted by antitrust agencies and is facing civil suits for damages, its
former members might still maintain (unilaterally, this time) supra-competitive prices in order to minimize the
evaluation of the damages.

Patrick Rey

10/11

EUI-RSCAS/EU Competition 2006 Proceedings

D.

Leniency and whistleblowing programmes

Economic analysis, both conceptual and empirical, can also serve to better understand what
makes cartels work or not work, in order to exacerbate cartel fragility and, by the same token,
contribute to cartel deterrence. Alternatively, one could say that competition agencies are
confronted with an information acquisition problem: firms know whether they collude; the
agencies do not. The agencies could therefore try and devise so-called revelation
mechanisms in order to induce the firms to report this information.42 This is the purpose of
the leniency programmes that grant favourable treatment to cartel members who come
forward with information that helps competition authorities to dismantle a cartel.
Economic analysis can be used to study the design of these leniency programmes so as
to improve their effectiveness; and indeed, there has recently been a body of work in this area,
starting with the works of M. Motta and M. Polo43 and G. Spagnolo.44 Several messages stem
from this emerging literature,45 for example:
it is good to restrict leniency to the first informant (provided that this informant
brings sufficient evidence or information leading to successful prosecution);
it may be a good idea to keep offering leniency (to a first informant) even once
an investigation is underway;
there is some complementarity between corporate and individual leniency
programmes;
it may be desirable to go further and offer bounties (monetary rewards, such as
a share in the fines imposed on the cartel members) to individual informants;
the stronger the stick (criminal sanctions such as fines and jail sentences) the
more effective the carrot of leniency; a weaker stick calls for larger amnesty
rates (or larger rewards).
While this body of work is still very much in progress, there lies a strong hope for
enhancing cartel detection and deterrence.

42

Building on the pioneering work of Maskin E. (Nash Implementation and Welfare Optimality", MIT 1977,
published in 66 Review of Economic Studies 23 (1999)), the literature on Nash and Subgame Perfect
implementation has confirmed the intuition that "a secret is no longer a secret when it is shared by several
agents". See Moores very nice survey, Implementation, contracts, and renegotiation in environments with
complete information, in Laffont J., ed., Advances in Economic Theory, Sixth World Congress, Econometric
Society Monographs, Vol. 1, 182- (1992).
43
Leniency Programs and Cartel Prosecution, 2 International Journal of Industrial Organization 347 (2003).
44
Optimal Leniency Programs, Discussion Paper, Fondazione Enrico Mattei (2000).
45
Besides the papers already mentioned, see Aubert C., Kovacic W. and Rey P., The Impact of Leniency and
Whistleblowing Programs on Cartels, International Journal of Industrial Organization (forthcoming);
Harrington J., Optimal Corporate Leniency Programs, Johns Hopkins University (2005); Frezal S., On
Optimal Cartel Deterrence Policies, International Journal of Industrial Organization (forthcoming); Rey P.
(2003): Toward a Theory of Competition Policy, in Dewatripont M., Hansen L. and Turnovsky L., eds.,
Advances in Economics and Econometrics: Theory and Applications, Eighth World Congress, Cambridge
University Press; Chen Z. and Rey P., Optimal Design of Leniency Mechanisms, mimeo, University of
Toulouse.

Patrick Rey

11/11