Tacit collusion

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Tacit collusion is a collusion between competitors who do not explicitly exchange information but achieve an agreement about coordination of conduct. [1] There are two types of tacit collusion: concerted action and conscious parallelism. [2] [3] In a concerted action also known as concerted activity, [4] competitors exchange some information without reaching any explicit agreement, while conscious parallelism implies no communication. [1] [5] In both types of tacit collusion, competitors agree to play a certain strategy without explicitly saying so. It is also called oligopolistic price coordination [6] or tacit parallelism. [7]

Contents

A dataset of gasoline prices of BP, Caltex, Woolworths, Coles, and Gull from Perth gathered in the years 2001 to 2015 was used to show by statistical analysis the tacit collusion between these retailers. [8] BP emerged as a price leader and influenced the behavior of the competitors. As result, the timing of price jumps became coordinated and the margins started to grow in 2010.

Conscious parallelism

In competition law, some sources use conscious parallelism as a synonym to tacit collusion in order to describe pricing strategies among competitors in an oligopoly that occurs without an actual agreement [9] or at least without any evidence of an actual agreement between the players. [10] In result, one competitor will take the lead in raising or lowering prices. The others will then follow suit, raising or lowering their prices by the same amount, with the understanding that greater profits result.

This practice can be harmful to consumers who, if the market power of the firm is used, can be forced to pay monopoly prices for goods that should be selling for only a little more than the cost of production. Nevertheless, it is very hard to prosecute because it may occur without any collusion between the competitors. Courts have held that no violation of the antitrust laws occurs where firms independently raise or lower prices, but that a violation can be shown when plus factors occur, such as firms being motivated to collude and taking actions against their own economic self-interests. [11] [12] This procedure of the courts is sometimes called as setting of a conspiracy theory. [13]

Price leadership

Oligopolists usually try not to engage in price cutting, excessive advertising or other forms of competition. Thus, there may be unwritten rules of collusive behavior such as price leadership. Price leadership is the form of a tacit collusion, whereby firms orient at the price set by a leader. [14] A price leader will then emerge and set the general industry price, with other firms following suit. For example, see the case of British Salt Limited and New Cheshire Salt Works Limited. [15]

Classical economic theory holds that Pareto efficiency is attained at a price equal to the incremental cost of producing additional units. Monopolies are able to extract optimum revenue by offering fewer units at a higher cost. An oligopoly where each firm acts independently tends toward equilibrium at the ideal, but such covert cooperation as price leadership tends toward higher profitability for all, though it is an unstable arrangement.

There exist two types of price leadership. [14] In dominant firm price leadership, the price leader is the biggest firm. In barometric firm price leadership, the most reliable firm emerges as the best barometer of market conditions, or the firm could be the one with the lowest costs of production, leading other firms to follow suit. Although this firm might not be dominating the industry, its prices are believed to reflect market conditions which are the most satisfactory, as the firm would most likely be a good forecaster of economic changes.

Auctions

In repeated auctions, bidders might participate in a tacit collusion to keep bids low. [16] A profitable collusion is possible, if the number of bidders is finite and the identity of the winner is publicly observable. It can be very difficult or even impossible for the seller to detect such collusion from the distribution of bids only. In case of spectrum auctions, some sources claim that a tacit collusion is easily upset: [17]

"It requires that all the bidders reach an implicit agreement about who should get what. With thirty diverse bidders unable to communicate about strategy except through their bids, forming such unanimous agreement is difficult at best."

Nevertheless, Federal Communications Commission (FCC) experimented with precautions for spectrum auctions like restricting visibility of bids, limiting the number of bids and anonymous bidding. [18] So called click-box bidding used by governmental agencies in spectrum auctions restricts the number of valid bids and offers them as a list to a bidder to choose from. [19] Click-box bidding was invented in 1997 by FCC to prevent bidders from signalling bidding information by embedding it into digits of the bids. [20] Economic theory predicts a higher difficulty for tacit collusions due to those precautions. [18] In general, transparency in auctions always increases the risk of a tacit collusion. [21]

Algorithms

Once the competitors are able to use algorithms to determine prices, a tacit collusion between them imposes a much higher danger. [22] E-commerce is one of the major premises for algorithmic tacit collusion. [23] Complex pricing algorithms are essential for the development of e-commerce. [23] European Commissioner Margrethe Vestager mentioned an early example of algorithmic tacit collusion in her speech on "Algorithms and Collusion" on March 16, 2017, described as follows: [24]

"A few years ago, two companies were selling a textbook called The Making of a Fly. One of those sellers used an algorithm which essentially matched its rival’s price. That rival had an algorithm which always set a price 27% higher than the first. The result was that prices kept spiralling upwards, until finally someone noticed what was going on, and adjusted the price manually. By that time, the book was selling – or rather, not selling – for 23 million dollars a copy."

The book "The Making of a Fly" by Peter Anthony Lawrence, written in 1992, briefly achieved a price of $23,698,655.93 on Amazon in 2011. [25] An OECD Competition Committee Roundtable "Algorithms and Collusion" took place in June 2017 in order to address the risk of possible anti-competitive behaviour by algorithms. [26]

It is important to distinguish between simple algorithms intentionally programmed to raise price according to the competitors and more sophisticated self-learning AI algorithms with more general goals. Self-learning AI algorithms might form a tacit collusion without the knowledge of their human programmers as result of the task to determine optimal prices in any market situation. [22] [27]

Duopoly example

Tacit collusion is best understood in the context of a duopoly and the concept of game theory (namely, Nash equilibrium). Let's take an example of two firms A and B, who both play an advertising game over an indefinite number of periods (effectively saying 'infinitely many'). Both of the firms' payoffs are contingent upon their own action, but more importantly the action of their competitor. They can choose to stay at the current level of advertising or choose a more aggressive advertising strategy. If either firm chooses low advertising while the other chooses high, then the low-advertising firm will suffer a great loss in market share while the other experiences a boost. If they both choose high advertising, then neither firms' market share will increase but their advertising costs will increase, thus lowering their profits. If they both choose to stay at the normal level of advertising, then sales will remain constant without the added advertising expense. Thus, both firms will experience a greater payoff if they both choose normal advertising (this set of actions is unstable, as both are tempted to defect to higher advertising to increase payoffs). A payoff matrix is presented with numbers given:

Firm B normal advertisingFirm B aggressive advertising
Firm A normal advertisingEach earns $50 profitFirm A: $0 profit
Firm B: $80 profit
Firm A aggressive advertisingFirm A: $80 profit
Firm B: $0 profit		Each earns $15 profit

Notice that Nash's equilibrium is set at both firms choosing an aggressive advertising strategy. This is to protect themselves against lost sales. This game is an example of a prisoner's dilemma.

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). Although this collusive arrangement is not an equilibrium in the one-shot game above, repeating the game allows the firms to sustain collusion over long time periods. This can be achieved, for example if each firm's strategy is to undertake normal advertising so long as its rival does likewise, and to pursue aggressive advertising forever as soon as its rival has used an aggressive advertising campaign at least once (see: grim trigger) (this threat is credible since symmetric use of aggressive advertising is a Nash equilibrium of each stage of the game). Each firm must then weigh the short term gain of $30 from 'cheating' against the long term loss of $35 in all future periods that comes as part of its punishment. Provided that firms care enough about the future, collusion is an equilibrium of this repeated game.

To be more precise, suppose that firms have a discount factor . The discounted value of the cost to cheating and being punished indefinitely are

.

The firms therefore prefer not to cheat (so that collusion is an equilibrium) if

.

See also

Related Research Articles

A duopoly is a type of oligopoly where two firms have dominant or exclusive control over a market, and most of the competition within that market occurs directly between them.

An oligopoly is a market in which control over an industry lies in the hands of a few large sellers who own a dominant share of the market. Oligopolistic markets have homogenous products, few market participants, and inelastic demand for the products in those industries. As a result of their significant market power, firms in oligopolistic markets can influence prices through manipulating the supply function. Firms in an oligopoly are also mutually interdependent, as any action by one firm is expected to affect other firms in the market and evoke a reaction or consequential action. As a result, firms in oligopolistic markets often resort to collusion as means of maximising profits.

<span class="mw-page-title-main">Price fixing</span> Agreement over prices between participants on the same side in a market

Price fixing is an anticompetitive agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.

Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to attain objectives forbidden by law; for example, by defrauding or gaining an unfair market advantage. It is an agreement among firms or individuals to divide a market, set prices, limit production or limit opportunities. It can involve "unions, wage fixing, kickbacks, or misrepresenting the independence of the relationship between the colluding parties". In legal terms, all acts effected by collusion are considered void.

A price war is a form of market competition in which companies within an industry engage in aggressive pricing strategies, “characterized by the repeated cutting of prices below those of competitors”. This leads to a vicious cycle, where each competitor attempts to match or undercut the price of the other. Competitors are driven to follow the initial price-cut due to the downward pricing pressure, referred to as “price-cutting momentum”.

Anti-competitive practices are business or government practices that prevent or reduce competition in a market. Antitrust laws ensure businesses do not engage in competitive practices that harm other, usually smaller, businesses or consumers. These laws are formed to promote healthy competition within a free market by limiting the abuse of monopoly power. Competition allows companies to compete in order for products and services to improve; promote innovation; and provide more choices for consumers. In order to obtain greater profits, some large enterprises take advantage of market power to hinder survival of new entrants. Anti-competitive behavior can undermine the efficiency and fairness of the market, leaving consumers with little choice to obtain a reasonable quality of service.

In theories of competition in economics, a barrier to entry, or an economic barrier to entry, is a fixed cost that must be incurred by a new entrant, regardless of production or sales activities, into a market that incumbents do not have or have not had to incur. Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices and are therefore most important when discussing antitrust policy. Barriers to entry often cause or aid the existence of monopolies and oligopolies, or give companies market power. Barriers of entry also have an importance in industries. First of all it is important to identify that some exist naturally, such as brand loyalty. Governments can also create barriers to entry to meet consumer protection laws, protecting the public. In other cases it can also be due to inherent scarcity of public resources needed to enter a market.

In economics, market power refers to the ability of a firm to influence the price at which it sells a product or service by manipulating either the supply or demand of the product or service to increase economic profit. In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing revenue. This indicates that the magnitude of market power is associated with the gap between P and MC at a firm's profit maximising level of output. The size of the gap, which encapsulates the firm's level of market dominance, is determined by the residual demand curve's form. A steeper reverse demand indicates higher earnings and more dominance in the market. Such propensities contradict perfectly competitive markets, where market participants have no market power, P = MC and firms earn zero economic profit. Market participants in perfectly competitive markets are consequently referred to as 'price takers', whereas market participants that exhibit market power are referred to as 'price makers' or 'price setters'.

<span class="mw-page-title-main">Non-price competition</span> Marketing strategy

Non-price competition is a marketing strategy "in which one firm tries to distinguish its product or service from competing products on the basis of attributes like design and workmanship". It often occurs in imperfectly competitive markets because it exists between two or more producers that sell goods and services at the same prices but compete to increase their respective market shares through non-price measures such as marketing schemes and greater quality. It is a form of competition that requires firms to focus on product differentiation instead of pricing strategies among competitors. Such differentiation measures allowing for firms to distinguish themselves, and their products from competitors, may include, offering superb quality of service, extensive distribution, customer focus, or any sustainable competitive advantage other than price. When price controls are not present, the set of competitive equilibria naturally correspond to the state of natural outcomes in Hatfield and Milgrom's two-sided matching with contracts model.

Bertrand competition is a model of competition used in economics, named after Joseph Louis François Bertrand (1822–1900). It describes interactions among firms (sellers) that set prices and their customers (buyers) that choose quantities at the prices set. The model was formulated in 1883 by Bertrand in a review of Antoine Augustin Cournot's book Recherches sur les Principes Mathématiques de la Théorie des Richesses (1838) in which Cournot had put forward the Cournot model. Cournot's model argued that each firm should maximise its profit by selecting a quantity level and then adjusting price level to sell that quantity. The outcome of the model equilibrium involved firms pricing above marginal cost; hence, the competitive price. In his review, Bertrand argued that each firm should instead maximise its profits by selecting a price level that undercuts its competitors' prices, when their prices exceed marginal cost. The model was not formalized by Bertrand; however, the idea was developed into a mathematical model by Francis Ysidro Edgeworth in 1889.

In game theory, the war of attrition is a dynamic timing game in which players choose a time to stop, and fundamentally trade off the strategic gains from outlasting other players and the real costs expended with the passage of time. Its precise opposite is the pre-emption game, in which players elect a time to stop, and fundamentally trade off the strategic costs from outlasting other players and the real gains occasioned by the passage of time. The model was originally formulated by John Maynard Smith; a mixed evolutionarily stable strategy (ESS) was determined by Bishop & Cannings. An example is a second price all-pay auction, in which the prize goes to the player with the highest bid and each player pays the loser's low bid.

An Edgeworth price cycle is cyclical pattern in prices characterized by an initial jump, which is then followed by a slower decline back towards the initial level. The term was introduced by Maskin and Tirole (1988) in a theoretical setting featuring two firms bidding sequentially and where the winner captures the full market.

In economics, market concentration is a function of the number of firms and their respective shares of the total production in a market. Market concentration is the portion of a given market's market share that is held by a small number of businesses. To ascertain whether an industry is competitive or not, it is employed in antitrust law and economic regulation. When market concentration is high, it indicates that a few firms dominate the market and oligopoly or monopolistic competition is likely to exist. In most cases, high market concentration produces undesirable consequences such as reduced competition and higher prices.

<span class="mw-page-title-main">Competition (economics)</span> Economic scenario

In economics, competition is a scenario where different economic firms are in contention to obtain goods that are limited by varying the elements of the marketing mix: price, product, promotion and place. In classical economic thought, competition causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater the selection of a good is in the market, the lower prices for the products typically are, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly).

<span class="mw-page-title-main">Auction theory</span> Branch of applied economics regarding the behavior of bidders in auctions

Auction theory is an applied branch of economics which deals with how bidders act in auctions and researches how the features of auctions incentivise predictable outcomes. Auction theory is a tool used to inform the design of real-world auctions. Sellers use auction theory to raise higher revenues while allowing buyers to procure at a lower cost. The conference of the price between the buyer and seller is an economic equilibrium. Auction theorists design rules for auctions to address issues which can lead to market failure. The design of these rulesets encourages optimal bidding strategies among a variety of informational settings. The 2020 Nobel Prize for Economics was awarded to Paul R. Milgrom and Robert B. Wilson “for improvements to auction theory and inventions of new auction formats.”

In game theory, an epsilon-equilibrium, or near-Nash equilibrium, is a strategy profile that approximately satisfies the condition of Nash equilibrium. In a Nash equilibrium, no player has an incentive to change his behavior. In an approximate Nash equilibrium, this requirement is weakened to allow the possibility that a player may have a small incentive to do something different. This may still be considered an adequate solution concept, assuming for example status quo bias. This solution concept may be preferred to Nash equilibrium due to being easier to compute, or alternatively due to the possibility that in games of more than 2 players, the probabilities involved in an exact Nash equilibrium need not be rational numbers.

European Union merger law is a part of the law of the European Union. It is charged with regulating mergers between two or more entities in a corporate structure. This institution has jurisdiction over concentrations that might or might not impede competition. Although mergers must comply with policies and regulations set by the commission; certain mergers are exempt if they promote consumer welfare. Mergers that fail to comply with the common market may be blocked. It is part of competition law and is designed to ensure that firms do not acquire such a degree of market power on the free market so as to harm the interests of consumers, the economy and society as a whole. Specifically, the level of control may lead to higher prices, less innovation and production.

<span class="mw-page-title-main">Market design</span>

Market design is a practical methodology for creation of markets of certain properties, which is partially based on mechanism design. In some markets, prices may be used to induce the desired outcomes — these markets are the study of auction theory. In other markets, prices may not be used — these markets are the study of matching theory.

A Markov perfect equilibrium is an equilibrium concept in game theory. It has been used in analyses of industrial organization, macroeconomics, and political economy. It is a refinement of the concept of subgame perfect equilibrium to extensive form games for which a pay-off relevant state space can be identified. The term appeared in publications starting about 1988 in the work of economists Jean Tirole and Eric Maskin.

United States v. Masonite Corp., 316 U.S. 265 (1942), is a United States Supreme Court decision that limited the scope of the 1926 Supreme Court decision in the General Electric case that had exempted patent licensing agreements from antitrust law's prohibition of price fixing. The Court did so by applying the doctrine of the Court's recent Interstate Circuit hub-and-spoke conspiracy decision.

References

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  3. ↑ Shulman, Daniel R. (2006–2007). "Matsushita and the Role of Economists with Regard to Proof of Conspiracy". Loyola University Chicago Law Journal. 38: 497. Retrieved 27 March 2021.
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  10. ↑ Ezrachi, Ariel; Stucke, Maurice E. (2017). "Emerging Antitrust Threats and Enforcement Actions in the Online World". Competition Law International. 13: 125.
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  12. ↑ Kevin Scott Marshall, Stephen H. Kalos, The Economics of Antitrust Injury and Firm-specific Damages (2008), p. 228.
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  14. 1 2 Sloman, John (2006). Economics. Financial Times Prentice Hall. ISBN   978-0-273-70512-3 . Retrieved 2 May 2021.
  15. ↑ Commission, Great Britain: Competition (30 November 2005). British Salt Limited and New Cheshire Salt Works Limited: A Report on the Acquisition by British Salt Limited of New Cheshire Salt Works Limited. The Stationery Office. ISBN   978-0-11-703625-3 . Retrieved 2 May 2021.
  16. ↑ Skrzypacz, Andrzej; Hopenhayn, Hugo (2001). "Tacit Collusion in Repeated Auctions" (PDF). Retrieved 16 April 2021.{{cite journal}}: Cite journal requires |journal= (help)
  17. ↑ Compte, Olivier (1998). "Communication in Repeated Games with Imperfect Private Monitoring". Econometrica. 66 (3): 597–626. doi:10.2307/2998576. ISSN   0012-9682. JSTOR   2998576 . Retrieved 16 April 2021.
  18. 1 2 Bajari, Patrick; Yeo, Jungwon (1 June 2009). "Auction design and tacit collusion in FCC spectrum auctions" (PDF). Information Economics and Policy. 21 (2): 90–100. doi:10.1016/j.infoecopol.2009.04.001. ISSN   0167-6245.
  19. ↑ "Bundesnetzagentur stärkt Deutschland als Leitmarkt für 5G" (PDF). Bundesnetzagentur. Retrieved 17 April 2021.
  20. ↑ Commission, United States Federal Communications (June 2008). FCC Record: A Comprehensive Compilation of Decisions, Reports, Public Notices, and Other Documents of the Federal Communications Commission of the United States. Federal Communications Commission. Retrieved 17 April 2021.
  21. ↑ Bichler, Martin; Gretschko, Vitali; Janssen, Maarten (1 June 2017). "Bargaining in spectrum auctions: A review of the German auction in 2015". Telecommunications Policy. 41 (5–6): 325–340. doi:10.1016/j.telpol.2017.01.005. hdl: 10419/145809 . ISSN   0308-5961.
  22. 1 2 Ezrachi, A.; Stucke, M. E. (13 March 2020). "Sustainable and unchallenged algorithmic tacit collusion". Northwestern Journal of Technology & Intellectual Property. 17 (2). ISSN   1549-8271.
  23. 1 2 "Horizontal Restraint Regulations in the EU and the US in the Era of Algorithmic Tacit Collusion". Journal of Law and Jurisprudence. 13 June 2018. doi: 10.14324/111.2052-1871.098 .
  24. ↑ Vestager, Margrethe (2017). "Algorithms and competition". European Commission. Archived from the original (Bundeskartellamt 18th Conference on Competition) on 2019-11-29. Retrieved 1 May 2021.
  25. ↑ Solon, Olivia (April 27, 2011). "How A Book About Flies Came To Be Priced $24 Million On Amazon". Wired . Retrieved 1 May 2021.
  26. ↑ "Algorithms and Collusion: Competition Policy in the Digital Age" (PDF). OECD. Retrieved 1 May 2021.
  27. ↑ Hutchinson, Christophe Samuel; Ruchkina, Gulnara Fliurovna; Pavlikov, Sergei Guerasimovich (2021). "Tacit Collusion on Steroids: The Potential Risks for Competition Resulting from the Use of Algorithm Technology by Companies". Sustainability. 13 (2): 951. doi: 10.3390/su13020951 .
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