Collusion, Cartels, and Price Fixing Agreements

Lecture 2Paper 9 / IIB (Industrial Policy)

Dr. J. Steinbuks

Lecture Outline

1. Concepts and Milestones 2. A Theory of Collusion

– Extension: Challenges to Collusion 3. A Practice of Collusion

– Empirical Study: Joint Executive Committee 4. Application of Antitrust Laws

– Case Study: Ethyl Corporation

Lecture Outline

1. Concepts and Milestones 2. A Practice of Collusion

– Extension: Challenges to Collusion 3. How Stable Cartels Are?

– Empirical Study: Joint Executive Committee 4. Application of Antitrust Laws

– Case Study: Ethyl Corporation

Concepts and Milestones

• Some Important Concepts– (Explicit) Collusion: direct communication

among firms to coordinate their anticompetitive behavour (e.g. ??)

– Cartel: consortium of colluding firms– Tacit Collusion: indirect communication

among firms to coordinate their anticompetitive behavour

– Price leadership: common form for tacit collusion (largest firm leads, other follow)

Concepts and Milestones

• Milestones– 1870s to 1890s: “golden era” of cartels

• Railroad and Ocean Transportation • Mining and Oil Extraction • Food product (Sugar, Beer)

Source: Levenstein andSuslow (JEL, 2006)

Concepts and Milestones

• Milestones– 1870s to 1890s: “golden era” of cartels

• Railroad and Ocean Transportation • Mining and Oil Extraction • Food product (Sugar, Beer)

– 1890s: Sherman Act prohibits cartels• Large cartels dissolved

– Aftermath 1890s: regular illegal cartel cases • Large fines imposed for Sherman Act violations

Source: US DOJ website (2009)

Lecture Outline

1. Concepts and Milestones 2. A Theory of Collusion

– Extension: Challenges to Collusion3. A Practice of Collusion

– Empirical Study: Joint Executive Committee 4. Application of Antitrust Laws

– Case Study: Ethyl Corporation

Theory of Collusion

• Infinitely Repeated “Workhorse” Game– 2 firms – Inverse Demand: p=100-q1-q2– Identical Constant Marginal Cost: c=40– Marginal Revenue: MR = 100 – 2q– Cournot Outcome: qc=20 pc=60 πc=400– Monopoly Outcome: qm=30 pm=70 πm=900– Firm’s discount rate is (unknown) r– Can firms do better by colluding?

Theory of Collusion

• Challenges to Collusion: – Coordination and Bargaining

• How to enforce compliance? • price leadership, markup pricing, basic points• Different coordination targets

– Imperfect Monitoring• How to distinguish cheating from business cycle?

– Change in Market Demand– Supply Shocks and Technological Change– Barriers to Entry

Lecture Outline

1. Concepts and Milestones 2. A Theory of Collusion

– Extension: Challenges to Collusion 3. A Practice of Collusion

– Empirical Study: Joint Executive Committee4. Application of Antitrust Laws

– Case Study: Ethyl Corporation

A Practice of Collusion

• Joint Executive Committee (Porter, 1983)• Research questions:

– How to distinguish empirically between competitive and collusive regimes?

– How stable cartels are?• Approach:

– Explore time frame when cartels were legal– Use observed demand shocks to identify the

model

A Practice of Collusion

• JEC: Railroad Cartel, 1880 – 1886• Market share allocation • Two cases of entry, but no cut-throating • Main competitor: water transportation• Demand rises in winter (lakes freeze)• Imperfect monitoring • Limited punishment, reversals allowed

A Practice of Collusion

• Econometric Approach:– “Structural” approach, two equations– Railroad service demand Qd =f(Pd,Lakes)

• Lakes: 1 if Great Lakes are open to navigation– Railroad service supply Ps =g(Qs, S, I)

• S: 1 for structural cartel changes (e.g. entry)• I: 1 if cartel breaks (observed / unobserved)

– Market clearing conditions Qd= Qs, Pd= Ps

– Estimation strategy: 2SLS, ML

A Practice of Collusion

log shipment price

log quantity shipped “cheating” dummy

Source: Porter (1983). Standard errors in parentheses.

A Practice of Collusion

“cheating” occurs

Lecture Outline

1. Concepts and Milestones 2. A Theory of Collusion

– Extension: Challenges to Collusion 3. A Practice of Collusion

– Empirical Study: Joint Executive Committee 4. Application of Antitrust Laws

– Case Study: Ethyl Corporation

Application of Antitrust Laws

• Facilitating practices: The Ethyl Case• Market for anti-knock compounds• Factors helping collusion:

– Highly concentrated market (4 firms) – Roughly equal market shares – Relatively homogenous product – Absence of good substitutes

• Prices stayed stable, though demand dropped

Application of Antitrust Laws

• Factors preventing collusion:– Prices were not transparent– Lumpy sales – High incentives to bargain for discounts – Product differentiation through transportation

costs • FTC sued industry under FTC Act

Section 5 (unfair competition)– Certain practices facilitate tacit collusion and

should be banned

Application of Antitrust Laws

• FTC arguments:– Prices stayed high despite demand drop– Companies facilitated collusion by

• Giving advance notice to price changes• Posting price changes in press• Using uniform delivered pricing• Adopting “most-favoured-client” (MFC) clause

– Prices are “too similar” despite product variation

Application of Antitrust Laws

• Industry defence:– Prices are not perfectly uniform– Substantial non-price competition– Press anouncements do not matter– Transportation costs are low– MFC clause wanted by clients– All facilitating practices were before

competition, so no intent to monopolize• FTC lost the case in the appeals court