Slides - Competition Policy International

David S. Evans
University of Chicago, Global Economics Group
Elisa Mariscal
CIDE, Global Economics Group
Topic 9 | Part 1
29 August 2013
Part 1
Part 2
Replicating the
outcome with
a cartel
and punishing
The incentives
to cheat
Methods to
detect and
punish cheaters
Economics of
Factors that
make collusion
Tacit collusion
and cartels
The Economics of Price Fixing
“People of the same trade
seldom meet together,
even for merriment and
diversion, but the
conversation ends in a
conspiracy against the
public, or in some
contrivance to raise
Adam Smith (1723-1790)
The Wealth of Nations, Book I,
Chapter X (1776)
The Economics of Price Fixing
Price fixing is per se illegal in the U.S., E.U. and many other jurisdictions.
• Illegal by virtue of the behavior regardless of its intent or effect, the
“inherent nature” of the practice is injuriously restraining trade.
• There is no allowable defense (though some industries are exempted)
• Focus in on the existence of an agreement (see Kaplow, Competition
Policy and Price Fixing for critique).
Per se prohibitions should be reserved for practices for which:
• There is an extremely high likelihood that the practice can have only an
anti-competitive effect.
• It is very difficult and costly to investigate claims of pro-competitive vs.
anti-competitive effects, making a per se approach economical
• The practice can be defined specifically enough so that companies can
identify what they are, and are not, allowed to do
The Six Palaces Price Fixing Scandal
Six exclusive Paris hotels were found guilty of price fixing:
the Hotel de Crillon, the Four Seasons Hotel George V,
the Hotel Ritz, the Hotel Plaza Athenee, the Hotel
Meurice, and Hotel Le Bristol.
They were fined a total of 709,000 Euros by the French
Competition Authority.
There were regular exchanges between the hotels
about the average room price, and room occupancy
“It is true that these practices exist and in very many
fields. If they are not legal, they are very common.”
Françoise Parguel, communications director for the
A graph of average room price shows there was very
little variations between the prices charged by the
colluding hotels during 2000 to 2001. (Is this convincing
economic evidence?)
Some Other Cartel Price Paths
Citric Acid
Cartel Duration
Harrington, CRESSE Lectures, 2011
Cartel Harm
% Price
countries $ million
Time period
# Firms
Sales $
Citric Acid
Steel Tube
Connor (2001), Levenstein y Suslow (2001), OECD, and World Integrated Trade Solution
database. SITC: Standard International Trade Code.
Fact About Cartels Data
Biased sample because we only observe discovered cartels.
Suppose only the less effective cartels are caught.
• Cartel duration has been underestimated.
• Welfare losses have been underestimated.
Suppose only the more effective cartels are caught because the less
effective ones collapse before being discovered.
• Cartel duration has been overestimated.
• Welfare losses have been overestimated
Policy challenge: How can we measure the efficacy of cartel
enforcement policies, when we cannot measure the number of
cartels in an economy?
Harrington, CRESSE Lectures, 2011
Replicating the Monopoly
Outcome with a Cartel
Agreements on Price and Agreements on
Price Agreements
Number of
identical firms = 20
Profit margin of $15 a unit and total profit
of $15 million.
PM = $20
PC = $5
Suppose there are 20 competing firms. With competition they each a charge
competitive price of $5 dollars, sell 100,000 units (total 2 million) and just earn a
competitive return.
If they each agree to charge $20, they sell 50,000 each on average (total 1 million)
and make $750,000 of monopoly profit each (total $15 million). [How does output
get allocated?]
Output Agreements
Competing firms in the example could achieve monopoly price if
they each agreed to offer only 50,000 units to the market:
• Divided up by geographic regions so that each sold 50,000 units
• Divided up by customers so that each had customers to whom
they could sell 50,000 units
We have assumed firms are all the same size and have the same
bargaining power. They could also divide things so that some got a
larger share of profits by getting a larger region or more customers.
Which is better: price agreement or output agreement?
Cartels with Two-Sided Platforms
Replicating monopoly outcome requires fixing
prices (or allocating output) on both sides
•If competing newspapers could fix subscription and
advertising prices they could exactly replicate the
monopoly outcome
•Note that this issue is different than “customers” on one
side colluding
If one side is constrained to zero then fixing price
on the other side replicates monopoly outcome
•If competing shopping malls fixed rental prices but
shoppers continued to get in for free they could replicate
the monopoly outcome
If a cartel can’t fix price on one side then:
•Monopoly profits get competed away if competition is
intense on other side
•Increased profits but suboptimal if imperfect competition
on other side
Fixed priced to buyers,
not clear to sellers
So You Want to Start a Cartel …
You and your accomplices need to reach an agreement on what to
do and how to divide up the loot.
You need to figure out how to make sure everyone abides by the
agreement and detect those who don’t.
You need to figure out how to deter cheating including punishing
those who engage in it.
You need to figure out how to prevent the competition authorities
and your victims from uncovering you.
The Incentives to Cheat
Importance of Cheating for Antitrust
Ability to detect and prevent cheating is key to having a cartel.
Cartels are more likely when detection and prevention are possible.
Detection and punishment methods leave traces of evidence that
authorities can look for.
Certain seemingly legal practices may “facilitate” detection and
prevention of cheating and therefore authorities may want to
prohibit or monitor these.
First look at role of cheating, then detection/punishment methods,
and conclude by looking at “facilitating practices”.
Incentives to Cheat on a Cartel Agreement
Could an individual firm do better than with the cartel?
The answer is always “yes” when it is certain that the other firms stick
with their cartel agreement (this case is unrealistic of course).
The answer may be “yes” whenever the gains from cheating exceed
the losses from either punishment or from de-stabilizing the cartel
(considered in our next example). The “cheater” just needs to make
enough extra profit long enough in order to outweigh the losses of
the cartel breaking down or possible “retribution”.
Effective cartels must be able to detect and punish cheating.
Incentives to Cheat on Price Agreement
Suppose firms 2 …. 20 charge the cartel (monopoly) price of $20.
Suppose firm 1 drops its price to $19.95.
Then all customers will buy from firm 1 (in a frictionless world).
• Firm 1 gets monopoly profits of almost $15 million (up from 750,000)
• Firms 2 … 20 get nothing
To avoid detection it could drop price but increase sales just enough
not to be detected. A successful cheater can’t be too greedy.
If many firms cheat competition reemerges.
Incentives to Cheat on Output Agreement
Each firm has the incentive to expand
output to where MR = MC (the profitmaximizing level given the fixed price).
If only one firm does so, it can get away
undetected if the increase is a small
fraction of total output.
If many firms follow this strategy, output
expansion will force price down and
destabilize the cartel.
Lysine cartel: one
Claimed it reported
“misleading” sales info to
the other companies and
other company hid 3500
tons of Lysine from the
cartel’s auditors.
Harrington, CRESSE Lectures, 2011
Incentives to Cheat
Brazen cheating won’t work for long because the other firms will be
better off returning to competition and at least getting their
competitive return.
But could cheating still be profitable? It will be if:
• The additional monopoly profit from cheating now outweighs the future
stream of monopoly profits lost as a result of precipitating the collapse of
the cartel
• Is it worthwhile in the example above?
Firms could profit by engaging in “a little cheating” but not enough
for others to figure it out. They could look for the optimal amount of
cheating that balances risk and rewards.
Cheating is an example of a game where each player must consider
its cheating strategy given its expectations about the cheating
strategies engaged in by others.
Cheating Makes It Hard for Cartels to Achieve
Monopoly Price
Every firm has the incentive to cheat a lot or a little.
Each firm has even more of an incentive to cheat, knowing that the
others have an incentive to cheat.
Even if every firm just cheats a little, in the aggregate this will lower
price towards the competitive level.
Note: this is important for calculation of cartel damages. Just
because firms aspire to price at the monopoly level they may not
succeed in doing so.
Methods for Detecting and
Punishing Cheaters
Detecting and Punishing Cheaters
To reduce cheating the cartel must be
able to:
• Detect cheating
• Punish cheating
Economic factors behind detection
and punishment are key to understand
viability of cartel agreements and ways
for enforces to help destabilize.
Detecting Cheating
Given incentives to cheat cartels and their participants must be able
to detect firms that are deviating from the agreement.
Some market situations make it easier to detect cheating:
• Goods are homogeneous
• Pricing is transparent
• Customer relationships are well known
Cartel and its members can also devise special arrangements to
make it easier to detect cheating
Output Allocation and Cheating
Exclusive territories: if a firm has exclusive rights to a region, the
appearance of a competitor alerts firm to cheating.
Exclusive customers: if a firm has exclusive rights to a customer then
the defection of that customer alerts firm to cheating.
Exclusive contract wins: with bidding rigging, one firm is designated
to be the winner of each contract; deviation is detected instantly.
But some of these methods can also raise suspicions and increase
likelihood of detection. Some cartels therefore incorporate some
Price Setting and Cheating
Shared resource with posted prices (airlines computer reservation
systems; multiple listing services for real estate)—transparency in price
Meeting competition clauses in contracts—customers therefore have
to reveal the existence of lower bids.
Common public distribution channel—so all competitors see all
prices; minimum resale price maintenance may be a facilitating
Other information exchanges and auditing mechanisms.
Detecting Cheating: Meeting Competition Clauses
Meeting Competition Clause requires a buyer to allow a seller to
keep business by meeting a competitor’s offer.
It detects cheating by alerting the seller that its customer is getting a
better offer from a competitor.
It halts cheating by preventing the other seller from making a sale.
Punishing Cheating: Brute Force
Death, dismemberment, torture.
Burning down factories.
Organized crime syndicates behind
bid rigging and collusion in many
industries dominated by smaller firms
(e.g. highway construction).
Punishing Cheating: Gentle or Not So Gentle
Target cheater’s customers with
low prices.
Predation strategy to drive
cheater out of business (see Basil
Yamey’s “Predatory Price
Cutting” reprinted in CPI Autumn
Punishing Cheating: Price Wars
If rivals deviate from agreed on
price this period then lower price
to competitive level next period.
This strategy leads to price wars
where periods of high prices are
followed by price wars.
To end price wars firms move
back to collusive equilibrium.
Entry and Cartels
High industry prices and profits attract entry. What does the cartel do
about this?
Bring entrant into the business… the cartel
• Entrant faces the same issue as the cheater;
• Needs to weigh profit from undercutting the cartel against its
future profits from joining it.
Prevent entry by raising barriers or “gently” nudging…
• Legal restrictions: licenses, regulation.
• Refusal to supply joint facility.
• Predatory and other exclusionary strategies.
Factors That Make Collusion
Easier to Sustain
Factors that Facilitate a Cartel
Facilitating factors include anything that increases the gains from
operating a cartel, helps detect cheating on a cartel, and enables
punishment of cheaters.
Facilitating factors include:
• Structural features of the market (number of firms, entry conditions, etc.)
• Institutional features (information exchanges, joint facilities, etc.)
• Contractual relationships and methods of transacting between buyers
and sellers.
Facilitating Factors—Structural Features
Smaller number of similar firms lowers gains from cheating (why?) and makes coordination easier (but
maybe tacit collusion is easier).
More symmetric firms make gains and losses from cheating more equal; with asymmetric firms largest
firms may gain from cheating while smaller firms can’t detect.
Entry barriers: easier entry disrupts collusion and makes gains harder since they must be shared with
entrants; paying off entrants attracts more entrants.
More homogenous products usually make coordination easier and also easier to detect cheating.
Greater linkages e.g. overlapping boards, family members, trade associations, and other meeting
places makes it easier to coordinate, increases trust, and makes punishment easier.
Many disconnected buyers: a small number of buyers can use buyer power to break cartel and, if
buyers can compare notes, more likely to detect cartel.
More stable demand makes coordination easier and makes it easier to detect cheating while growing
demand increases cost of killing cartel (discounted future gains exceed current gains).
Facilitating Factors—Institutional Features
Information exchanges—formal mechanisms
for collecting and exchanging price and sales
information that can be used to coordinate
pricing and detect cheating; that’s what the six
palaces had (how about cost information?)
Trade associations and meetings—activities
that promote contact, provide opportunities
for exchanging information, and form social
bonds that increase trust and raise the cost of
Access to joint facilities—Businesses that
cooperate in creating a joint facility can use
the facility to monitor output, discipline
cheaters by denying them access, and
preventing entry. E.g., airline reservation
Facilitating Factors—Contractual Practices
Most favored customer clauses require the seller not to charge a favored
customer less than the lowest it charges any other customer (might be
applied contemporaneously or retroactively leading to rebates). Makes it
more expensive to cheat (but if competitors don’t know, how would the
customer?) and more expensive to retaliate (same point).
Meeting-competition clauses gives the seller the opportunity to match a lower
price offered by the competition. It leads to exchange of information (and
therefore detection of cheating) and makes cheating less profitable (since
existing seller may match).
Resale price maintenance requires distributors to charge a given price. This
makes it easier to observe deviations from prices.
Question: should these contractual practices be prohibited? What do you
need to know to help answer this?
End Part 1, Next Class Part 2
Part 1
Part 2
Replicating the
outcome with a
and punishing
The incentives
to cheat
Methods to
detect and
punish cheaters
Economics of
Factors that
make collusion
Tacit collusion
and cartels vs.

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