VIRGIN MOBILE: AP ricing Decision - PowerPoint by 4eRF2dd



Collusion and Cartels
   What is collusion?
     An attempt to suppress competition

   What is a cartel?
     A group of firms who have agreed explicitly to coordinate
      their activities to raise market price or decrease market
     Cartel members agree to coordinate their actions

        prices
        market shares
        exclusive territories
     Prevent excessive competition between the cartel members
Why doesn't everyone collude?
   Illegal.
     In the US, collusive agreements cannot be enforced by
      legal contracts
     International cartels do exist, however.

   Hard to come to an agreement.
   Strong incentives to cheat -- collusion may not be
Types of Collusion

 Tacit Coordination/Facilitating Practices.
 Explicit Conspiracy.
Tacit Coordination
   Spontaneous cooperation resulting from strongly
    perceived interdependence.
   For example, following a rival’s price change.
   Difficult to achieve with lots of firms.
   Hard to find/prove/correct.
   Facilitating practices
     Price matching

     Most Favored consumer clause
Explicit Conspiracy
 Price fixing agreement.
 Formal cartel.

 Per se illegal.
   What are the Incentives to Collude?

Start with a simple model of a Bertrand Duopoly.
Without collusion, p1*= p2*= c and thus i = 0 .
Industry quantity is set at the perfectly competitive level.
For a monopolist, price is set where MR = MC:
   P = a-bQ so MR = a -2bQ.
   Set c = a-2bQ and solve for monopoly quantity and price.
   QM = (a-c)/2b and PM = (a+c)/2
So M = (PM - c)*QM = (a+c - 2c)/2 * (a-c)/2b = (a-c)2/4b
If each firm produces 1/2 QM, each gets (a-c)2/8b
Collusion in the Prisoner’s Dilemma Framework

                                               Firm 2

                                    Collude             Defect

                  Collude      (a-c)2/8b, (a-c)2/8b

                   Defect                                0, 0

  But what about the two empty cells?
   To fill in the two empty cells:

If one firm sets price at the monopoly level, what price will the
cheater set?

pi* = pM- .
Then the cheater gets all the demand and earns a profit only
slightly less than what a monopolist would get:
   C = (PM--c)*(QM +)  ((a+c)/2 -c)*(a-c)/2b = (a-c)2/4b.
Profit of non-cheater is 0.
Collusion in the Prisoner’s Dilemma Framework

                                        Firm 2

                           Collude                  Defect

            Collude   (a-c)2/8b, (a-c)2/8b       0, (a-c)2/4b

            Defect       (a-c)2/4b, 0                0, 0
Factors that Affect the Success of Collusion

      Potential for monopoly profit
        demand    relatively inelastic
        ability to restrict entry
          common     marketing agency or trade association
                persuade consumers of advantages of buying from agency members
                    low search costs

                    security

                    control access to the market

                    persuade consumers that buying from non-members is risky

                    use marketing power

                   Examples: National Realtor Association, American Dentist
Factors that Affect the Success of Collusion

      Low costs of reaching a cooperative agreement
        small   number of firms in the market
          lowers   search, negotiation and monitoring costs
        similar   production costs
          avoids   problems of side payments
                detailed negotiation
                misrepresentation of true costs
        lack   of significant product differentiation
          again simplifies negotiation – don’t need to agree prices,
           quotas for every part of the product spectrum
Detecting Collusion
   Historically, what factors have made industries
    susceptible to collusion?
     Fraas  and Greer find markets with small number of
      firms and uncomplicated setting conducive to
      collusion. Also trade associations and common sales
      agencies facilitate collusion.
     Hay and Kelley find similar results and additionally
      that product homogeneity increases collusion.
Collusion and cartels
   Cartels have always been with us; generally hidden
       electrical conspiracy of the 1950s
       garbage disposal in New York
       Archer, Daniels, Midland
       the vitamin conspiracy
   But some are explicit and difficult to prevent
       OPEC
       De Beers
Recent events
   The 1990s saw record-breaking fines being imposed on
    firms found guilty of being in cartels
       illegal conspiracies to fix prices and/or market shares
       Archer-Daniels-Midland $100 million in 1996
       Hoffman-LaRoche $500 million in 1999
   Cartel violations in the 90s
F. Hoffman-LaRoche Ltd.                      Vitamins           1999   $500    International
BASF AG (1999)                               Vitamins           1999   $225    International
SGL Carbon AG                           Graphite Electrodes     1999   $135    International
UCAR International Inc.                 Graphite Electrodes     1998   $110    International
Archer Daniels Midland co.             Lysine and Citric Acid   1997   $100    International
Haarman & Reimer Corp.                      Citric Acid         1997   $50     International
HeereMac v.o.f.                         Marine Construction     1998   $49     International
Hoechst AG                                   Sorbates           1998   $36     International
Showa Denko Carbon Inc.                 Graphite Electrodes     1998   $32.5   International
Fujisawa Pharmaceuticals Co.             Sodium Gluconate       1998   $20     International
Dockwise N.V.                          Marine Transportation    1998   $15     International
Dyno Nobel                                  Explosives          1996   $15      Domestic
F. Hoffman-LaRoche Ltd.                     Citric Acid         1997   $14     International
Eastman Chemical Co.                         Sorbates           1998   $11     International
Jungblunzlauer International                Citric Acid         1997   $11     International
Lonza AG                                     Vitamins           1998   $10.5   International
Akzo Nobel Chemicals BV & Glucona BV     Sodium Gluconate       1997   $10     International
Practices that Facilitate Tacit Pricing
Firms can facilitate cooperative pricing by
 Price leadership

 Advance announcement of price changes

 Most favored customer clauses

 Price Matching
Price Leadership
   The price leader in the industry announces price
    changes ahead of others and they match the
    leader’s price
   The system of price leadership can break down if
    the leader does not retaliate if one of the follower
    firms defects
Price Matching Guarantees

   Price matching guarantees
     helps   a firm to protect its consumers and charge a high
     It makes your competitor “soft.” Takes away the
      benefit for your competitor to undercut your price.
   Price matching guarantee is simply a mechanism for tacit collusion
    or competition reduction between firms.

   Any offer of the price matching guarantee means effectively taking
    away any gains that its competitor might get from cutting price.

   If a firm offers a price matching guarantee, then a search consumer
    will buy from it because the consumer knows that in the event that
    there is slower price offered in the market the consumer is insured
    that it will match that price.

   Since price matching takes away the gain from price cutting, no firm
    cuts price and price competition is reduced.
    Another Example
   Two firms: Firm 1 and Firm 2
   Two prices: low ($4) or high ($5 )
   3000 captive consumers per firm
   4000 floating go to firm with lowest price

                                   Firm 2
                            Low             High
                Low          ,               ,
      Firm 1
                High         ,               ,
    Contracting with Customers
   The game is a prisoner’s dilemma
     Both firms prefer:     {High, High}
     Only equilibrium:      {Low , Low}
     Cannot credibly promise to play High

     Even if committed to High, other firm would still respond
      with Low
   How to resolve this?
     Third   party contracts with customers
Price Matching

   If one firm charges low, it does not gain any
    additional customers, since the competitor
    “automatically” matches it.

   What is the effect on the game?
Price Matching

                           Firm 2
                       Low       High
              Low    20 , 20   28 , 15
     Firm 1
              High   15 , 28   25 , 25

                           Firm 2
                       Low       High
              Low    20 , 20   20 , 20
     Firm 1
              High   20 , 20   25 , 25

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