Tacit Collusion


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Tacit Collusion

  1. 1. Collusion What is Harmful & What is not? By Sameh Al-Anani
  2. 2. What is (Really) meant by Collusion? <ul><li>An agreement, usually secretive, which occurs between two or more persons to limit open competition by deceiving, misleading, or defrauding others of their legal rights, or to obtain an objective forbidden by law typically by defrauding or gaining an unfair advantage </li></ul><ul><ul><li>In other words, it is an agreement among firms to divide the market, set prices, or limit production. </li></ul></ul>
  3. 3. How does it happen? <ul><li>Collusion takes place within an industry when rival companies cooperate for their mutual benefit. </li></ul><ul><li>Collusion most often takes place within the market structure of oligopoly , where the decision of a few firms to collude can significantly impact the market as a whole. </li></ul>
  4. 4. Types of Collusion <ul><li>Explicit collusion: Cartels. </li></ul><ul><li>Tacit collusion: Occurs when cartels are illegal or explicit collusion is absent. </li></ul><ul><ul><li>In other words: two firms agree to play a certain strategy without explicitly saying so. </li></ul></ul><ul><li>Any other combination of both </li></ul>
  5. 5. How does it work? <ul><li>When competitors do not want to engage in price cutting, excessive advertising or other forms of competition, they think about unwritten rules of collusive behavior such as price leadership (tacit collusion). </li></ul><ul><ul><li>A price leader will then emerge and sets the general industry price, with other firms following. </li></ul></ul>
  6. 6. Example (in the case of duopoly ) <ul><li>Two firms A and B </li></ul><ul><ul><li>Both play an advertising game over an indefinite number of periods </li></ul></ul><ul><ul><li>Both of the firms' payoffs are dependent upon their own action, but more importantly the action of their competitor. </li></ul></ul><ul><ul><li>They can choose to stay at the current level of advertising or choose a more aggressive advertising strategy. </li></ul></ul><ul><li>Outcome: </li></ul><ul><ul><li>In general, if the payoffs for colluding (normal, normal) are greater than the payoffs for cheating (aggressive, aggressive), then the two firms will want to collude (tacitly). </li></ul></ul>
  7. 7. Payoff Matrix of the Game Each earns 15 profit Firm A: 80 profit Firm B: 0 profit Firm A aggressive advertising Firm A: 0 profit Firm B: 80 profit Each earns 50 profit Firm A normal advertising Firm B aggressive advertising Firm B normal advertising
  8. 8. Conclusion <ul><li>In a market like this: the most reliable firm emerges as the best indicator of market conditions, </li></ul><ul><li>or the firm could be the one with the lowest costs of production, leading other firms to follow. </li></ul><ul><li>Although this firm might not be dominating the industry, its prices are believed to reflect market conditions, which are the most satisfactory. </li></ul><ul><li>The firm would most likely be a good forecaster of economic changes. </li></ul>
  9. 9. Barriers <ul><li>There can be significant barriers to collusion. In any given industry, these may include: </li></ul><ul><ul><li>The number of firms: As the number of firms in an industry increases, it is more difficult to successfully organize, collude and communicate. (good) </li></ul></ul><ul><ul><li>Cost and demand differences between firms : If costs vary significantly between firms, it may be impossible to establish a price at which to fix output. (good) </li></ul></ul><ul><ul><li>Cheating: There is considerable incentive to cheat on collusion agreements; although lowering prices might trigger price wars , in the short term the defecting firm may gain considerably. (good) </li></ul></ul><ul><ul><li>Potential entry: New firms may enter the industry, establishing a new baseline price and eliminating collusion (though anti-dumping laws and tariffs can prevent foreign companies entering the market). (bad) </li></ul></ul><ul><ul><li>Economic recession: An increase in average total cost or a decrease in revenue provides incentive to compete with rival firms in order to secure a larger market share and increased demand. (good & bad) </li></ul></ul>