3

Collusion and horizontal agreements

Different forms of collusive agreements:
price fixing
allocation of production quotas
market sharing

Two types of collusion:

Explicit collusion
Tacit collusion

 Any collusive agreement always involves 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 firm might not deviate from a collusive agreement if it knows that a

deviation will be quickly detected and punished.

 Fundamental trade-off facing each firm that enters into a collusive agreement:
Instantaneous profit gain of deviation versus expected loss from punishment.
In general: the less firms discount future profits, 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 firms in the industry.
The more firms, the larger the benefits of deviating.
Fewer firms make coordination easier.

Entry barriers:
The easier it is for new firms 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.
Easier to determine whether a drop in sales is due to demand fluctuations or price-undercutting by rivals.

Symmetry:
Easier to coordinate on a collusive agreement that benefits all firms.

Price transparency:
Exchange of price/quantity information.

3.2
3.2.1

Analysis of collusion in a supergame

A general model

n firms play an infinite horizon game.

If all firms choose a collusive action:

ci is current profits for firm i.
Vic is the (discounted) present value of all future profits.

 If firm i deviates from the collusive agreement:

di is the current profit in the deviation period (before detection).
p

Vi is the (discounted) present value of all future profits (after detection).

Firms discount the future by a factor (0, 1) .

If r is the interest rate between two periods, the discount factor is
1
=
.
1+r
Alternatively: represents uncertainty about when the game ends.

 Collusion is a Nash equilibrium outcome if each firm prefers to play the

collusive action rather than to deviate from it.
Firm i has no incentive to deviate from the collusive action if
ci + Vic di + Vip,
or
di

ci

Vic

Vip

This condition holds if the discount factor is sufficiently high:

di ci
i := c
,
Vi Vip
and the condition must hold for all i = 1, ..., n.
Sustaining collusion is possible only if the players are sufficiently patient!

3.2.2

A specific model

n identical firms play an infinitely repeated game.

Homogeneous products.

Constant unit costs c.

Bertrand competition.

Discount factor .

 If all firms set the same price p, then they share demand and total profit
such that
D (p)
Di (p) =
n
and
(p)
i (p) =
.
n
Trigger strategies:
At t = 0, each firm sets the collusive price pm that maximises joint
profits.
At each point in time t > 0, each firm sets the price pm if all firms
have set the price pm in all previous periods. Otherwise, each firm sets
p = c forever.

 These trigger strategies will constitute a Nash equilibrium with a collusive

outcome pi = pm in each period if




(pm)

2
3
2
3
1 + + + + ... (pm) + 0 + + + ...
n

Since

 t
1 , the above inequality can be written as

=
t=0
1

1
:= 1 .
n
A higher number of firms reduces the critical discount factor = makes
collusion more difficult to sustain!