Download Lecture Three - the School of Economics and Finance

Lecture Three
Oligopoly and Market Collusion
Learning objectives
Students should be learnt about
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Understand some features of a oligopoly market tend to market collusion
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Look into different cases of price fixing
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Development of cartel
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Understand the price coordination in the market place
Features of Oligopoly
The Cournot model
Duopolists A and B face industry demand
P=100-Q, Q=QA+QB
Each firm takes the other’s output as fixed
E.g., PA=(100-QB*)-QA
Marginal revenue for A is
MRA=(100-QB*)-2QA
If MC=0 (simplify), profit is maximized if QA=50-.5QB, which is reaction function of
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the duopoly A
Other firm takes the A’s output as fixed
E.g., PB=(100-QA*)-QB
Marginal revenue for B is
MRB=(100-QA*)-2QB
If MC=0, profit is maximized if QB=50-.5QA, which is reaction function of duopoly B
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Cournot equilibrium
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Comparison of prices and output among different equilibria
The Oligopoly Problem
z Prohibitions against Horizontal Agreement
z Small number of firms
z Interdependence
z Strong incentive to collude
z Recognition of interdependence removes incentive to compete
z In oligopoly non-competitive outcome possible without actual collusion.
Collusive Behaviors and Cartel
Collusive behavior
z Price Fixing
z Bid Rigging
z Market Allocation
z Joint Boycott
z Quota
z Discriminatory Standard
Cartels – An “efficiency’ cooperation, or a policy-induced cooperation, or a
regulated market cooperation
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Per Se Rule against Price Fixing
z Per se rule means that only need to prove the conduct such as a cartel
agreement, no need to show economic harm.
z Per se subsequently upheld by the Supreme Court Standard Oil Company of New
Jersey et. al. v. US, 221 US 1 (1911).
{ US Supreme Court subsequently rejected claims that it was legal to fix
prices provided they were reasonable.
{ “The aim and result of every price-fixing agreement, if effective, is the
elimination of one form of competition. The power to fix prices, whether
reasonably exercised or not, involves the power to control the market and
to fix arbitrary and unreasonable prices. The reasonable price fixed today
may through economic and business changes become the unreasonable
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price of tomorrow. Once established, it may be maintained unchanged
because of the absence of competition secured by the agreement for a price
reasonable when fixed.” US v. Trenton Potteries Company et. al. 273 US 392
(1927).
Oligopolists Take Rivals Reactions into Account in Setting Prices
z Study of pricing behaviour of UK firms indicated that a significant proportion
were reluctant to cut prices for fear of triggering a price war.
{Hall, Walsh and Yates (1996): How do UK Companies Set Prices, Bank of
England, Quarterly Bulletin (May).
UK Banks
z “In such a concentrated structure, it is to be expected that there will be a
recognition, however independently, on the part of the companies concerned
that price competition is likely to be damaging to them. A price cut that
generates little or no increased sales would not be profitable. One that does
increase sales, at competitors’ expense, is likely on that account to trigger price
cuts by competitors, such that all would end up less profitable than they
previously were. In such circumstances there would be a strong disincentive
to price cutting. In consequence price competition will be weakened, and
largely limited to any segment of the market where such considerations do not
apply.”
{ Competition Commission (2002): The Supply of Banking Services by Clearing
Banks to Small and Medium-sized Enterprises, CM5319, Para. 2.141.
Explicit v. Tacit Collusion
z Phlips (1995): they have the same objectives
{ Explicit collusion aims at putting the members of an agreement at the point
on the profit frontier at which their joint profit is maximised.
{ Tacit collusion aims at increasing the profits of the colluders above the level
implied by a non-cooperative Cournot-Nash equilibrium until, hopefully,
the joint profit maximising point is reached.
z More complicated with tacit collusion due to absence of agreement in the form
of a legally enforceable contract
z Tacit collusion typically because such contracts are illegal.
Explicit Collusion
z The Lysine Cartel
{US DoJ Antitrust Division Website Case filings United States v. Michael
Andreas and Terence Wilson.
{ADM new entrant initiate the cartel
{Famous quote “Our competitors are our friends; our customers are the
enemy”. (Senior ADM executive outlining the company’s philosophy at a
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cartel meeting)
{The Video
z Agreement on price, Volume allocation Side payments
z Role of Trade Associations
z Secrecy
z Adverse effect on buyers 25% mark up
{Understand more about cartels with Modern Game Theory Mode
The problem of “cheating”
{ “No one has yet invented a way to advertise price reductions which brings
them to the attention of numerous customers but not to that of any rivals.”
{ Stigler (1964), A Theory of Oligopoly, Journal of Political Economy, 72: 44-61.
Milk Bid Rigging Case
z A case on how to detect collusion
z Public education authorities will ask for bid for the supply of milk every year
{Milk is quite a homogenous product
{The cost structure is the same
{Only matter is the transportation cost
z More than 600 school district in Ohio
z A district purchase 50K half pints of whole white and 30K half pint of
chocolate milk for 450 students
z Raw milk thru processed by standardizing the butter fat content and then
pasteurizing, packaging and delivering.
z Total incremental cost is 10 cents
z Bid rigging is per se offence in US
z Economic Evidence to prove the behavior
{Evidence on the incentives to collude
{Evidence whether the behavior is more consistent with competition or
collusion
{Evidence on the extent of damages
Factors Facilitating Collusion
z Compete only on price
z Publicly announcing bids and the identity of the bidders – able to detect
“cheating” on the collusion
z Periodically bidding exercise –help retaliation
z Set of firms submit bid is small and stable
z District defines the market allocation
z Predictable Demand – help retaliation
z Many trade associations – help communications
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z
z
z
z
Competitors meet very frequency
Price information is available
Similar cost structure and production processes
Competitors also customers of one another
Analysis and Effects
z If there is no bid rigging, what would you observe about the bids?
{ Far way bidders bid higher
{ But if there is bid rigging, the closest one bids higher
z Porter and Zona conduct a regression analysis on the winning bid on variables
{ Contract terms
{ Cost of potential bidder – the distant travel
{ Measures of competition:
z HHI within 75 miles
z Change in HHI within 75 miles with a suspected conspiracy
{ An average of 6.5% price elevation over 10 years excluding years the cartel
indictment
{ With market power, average price increase can be 24.6%
z John Nash, the Nobel Prize winner analyzing selfish rivalries in market phenomena if
each firm does its best it can given rival’s actions
z For example the duopoly market:
{ Two firms both do their best it can, given expectation of their rival behaviors
{ Behaviors are non-cooperative
{ Two firms when considering a low price or a high price strategy, it formulates
its strategy upon its rival’s response
{ Cooperation has an anti-trust implication
Nash
Equilibrium
of a
single/finite
business
interaction
Nash
Equilibrium
of repeated
business
interaction
Tacit Collusion and Facilitating Practices.
z Definition of concerted practice.
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z “….a form of co-ordination between undertakings which, without having
reached the stage where an agreement properly so called has been concluded,
knowingly substitutes practical co-operation between them for the risks of
competition.”
z Case 48/69 ICI v. Commission (“dyestuffs”) [1972] ECR 619.
How Much Cooperation Required
z In Suiker Unie ECJ held that concept of concerted practice did not require the
working out of an actual plan and that:
z “…each economic operator must determine independently the policy which
he intends to adopt on the common market including the choice of the persons
and undertakings to which he makes offers or sells…[T]his
requirement …does,…, strictly preclude any direct or indirect contact between
such operators…to influence the conduct on the market of an actual or
potential competitor or to disclose to such competitor the course of conduct
which they themselves have decided to adopt or contemplate adopting on the
market.” Case 47/73, Suiker Unie v. Commission [1975] ECR 1663.
The Great Salt Duopoly
z MMC (1986): White Salt: A Report on the Supply of White Salt in the United
Kingdom by Producers of Such Salt, London: HMSO
{Firms acted “to restrain competition”.
{Evidence of price communications.
z Rees (1993): Collusive Equilibrium in the Great Salt Duopoly, Economic Journal ,
103: 833-48, reproduced in Phlips ed. Applied Industrial Economics
z Rejects arguments that parallel price changes result of competition.
z In “homogenous price-setting duopoly with exogenous capacity constraints,
non-cooperative behaviour does not result in identical prices.”
Parallel Behaviour Not Enough
z Commission relied on parallel price changes over a period of several years.
z Court held it had failed to prove collusion.
z Parallel behaviour not enough if there is an alternative explanation of such
behaviour.
z See Phlips (1995) on this case.
z Such collusion impossible to prove
The Ethyl Case
z US Case of Facilitating Practices/Concerted Practices
Lead-based anti-lock compound Industry
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z A decline industry
z Four major players: DuPont, Ethyl, PPG and Nalco
z Industry total turnover 400million pounds in 1980
z Product characteristics
What is the main issue?
{Sherman Act only outlaw “explicit” collusive agreement but how about
Oligopoly Problem, tactic cooperation
{What is the problem? Phenomena – parallel pricing, Why?
{One party increases price leading to other to follow.
z Two important elements: ability and incentive
Legal Arguments
z Du Pont advance announcement of price rises is not a concerted practices.
{ Court rejected collusion if alternative explanation for such behaviour.
{ Record showed that Du Pont had pre-announced price increases even when
it had a monopoly.
Factors influences facilitating practices
{ Non-public prices
{ Lumpy Sales
{ Complex and non-fungible products
{ Market concentration
But Problems When Other Explanation Lacking.
z Re Coordinated Pretrial Proceedings in Petroleum Products Antitrust Litigation, 906
F.2d 432 (1990).
z Oil companies disseminated information regarding their wholesale and retail
prices for the purposes of quickly informing competitors of a price change in
the hope that they would follow suit
z Court found some of the information circulated was only of interest to the
companies and their franchisees and that there was no legitimate business
reason for circulating the information to individual retailers.
A final thought on information exchange.
z Phlips (1995, p.82) criticises competition authorities for assuming
information exchanges is proof of collusion.
z Difficulties of enforcing collusion, simple exchange of information cannot be
construed as implying a collusive outcome is being achieved.
z All it could show is collusive conduct, “in the sense that the oligopolists are
trying to achieve a collusive outcome.” (Emphasis in original).
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Discipline of Cartel
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