Oligopoly, Collusion, and Antitrust in Economics

Chapter 4 Oligopoly, Collusion, and Antitrust

Game Theory Example 1: Advertising Competition Consider a duopoly in which firms do not compete on price because of collusion or regulation Example 2: Compatibility of Standards Consider a comparison of firms in which firm 1 is a supplier of VCRs and firm 2 is a supplier of videocassettes

The Strategic Form of a Game In game theory, a game is a well-defined object Game theory is a tool that provides insight concerning the strategic behavior of firms Vocabulary Strategic form Strategy set Payoff function

Nash Equilibrium Having modeled a particular economic setting as a game, one can use it to recommend to players how they should play or to make predictions about how they will play Strategy: a decision rule that instructs a player how to behave over the course of the game The concept of Nash equilibrium

Oligopoly Theory The Cournot Model An oligopoly is an industry with a small number of sellers The essence of oligopoly is recognized interdependence among firms Review Augustin Cournot s 1838 modeling of the oligopoly problem Observe that in both example games, the Nash equilibrium is Pareto inefficient in that firms could raise both of their profits by jointly acting differently

Other Models of Oligopoly Heinrich von Stackelberg developed the Stackelberg model in 1934 Joseph Bertrand established the Bertrand model, which assumed that firms choose price rather than quantity

Product Differentiation The more differentiated one s product is, the more one is able to act like a monopolist Product differentiation is when some consumers are willing to buy a competitor s product even at a price above that of other firms products

Collusion A Theory of Collusion If firms could somehow manage to coordinate so as to jointly reduce their outputs, they could increase profits for everyone This is what collusion is all about Explain how the inadequacy of the Cournot solution lies in the limitations of the Cournot model

Challenges to Collusion Coordination and bargaining Effective collusion requires that firms solve two challenges: coordination and compliance Define explicit collusion and tacit collusion Ways in which firms engage in tacit collusion By publicly announcing a change in corporate strategy The use of advance price announcements

Challenges to Collusion Compliance and stability Monitoring compliance is a challenging task for many cartels Consider the citric acid example and the German cement cartel example

Case Studies of Collusion Each of the following case studies highlights an important point related to collusion The railroad cartel of the nineteenth century exemplifies how cartels can routinely break down only to come back Nasdaq market makers show how tacit collusion can emerge even in markets with many firms The case involving toy retailers in London shows how an upstream firm can play a pivotal role in promoting coordination

Railroads and Price Wars Due to Imperfect Monitoring The creation of the Joint Executive Committee Review the Cournot model examined earlier: P = 100 q1 q2 Competition produces stable low prices, not temporary low prices Price wars are a by-product of collusion

Nasdaq Market Makers and Price Transparency Bid price: the price at which a market maker is willing to buy a stock Ask price: the price at which a market maker is willing to sell a stock Consider William Christie and Paul Schultz s observation and hypothesis

Toy Stores and Hub-and-Spoke Collusion In the canonical cartel, competing firms expressly communicate with one another about what prices to charge but some cartels have involved competitors communicating through another firm in the production chain Consider the case involving the toy manufacturer Hasbro

Antitrust Law and Enforcement with Respect to Price Fixing Fundamental Features of the Law Define what it means to unlawfully collude Unreasonable restraints of trade Consider various cases, such as United States v. Trans-Missouri Freight Association and Appalachian Coals, Inc. v. United States

The Concept of an Agreement What exactly is illegal, and what is sufficient to prove illegality? State the Supreme Court s definition of an agreement Review the four cases between 1939 and 1954 that served to define the boundaries for what it means to have an agreement that violates section 1 of the Sherman Act

Parallelism Plus The evidentiary standard of parallelism plus came out of the decisions surrounding conscious parallelism A plus factor is actions or outcomes that are largely inconsistent with firms acting independently and largely consistent with explicit coordination among firms Consider the relevant 1969 U.S. v. Container Corporation of America case

Legal Procedures Consider the 2007 Bell Atlantic Corp. v. Twombly case Summary judgement

Enforcement Policy Damages The focus here is on corporate penalties associated with price fixing and an enforcement tool leniency programs that has been widely adopted by many countries in recent years Public enforcement, private enforcement, and treble damages Consider the different rules regarding damages between the European Union and the United States

Enforcement Policy Fines The U.S. Federal Sentencing Guidelines and the European Commission Guidelines (2006) Corporate leniency programs The pros and cons of the DOJ leniency program established in 1978 Leniency: not being criminally charged for the activity being reported The power of the leniency program lies in taking advantage of each firm s fear that the other firm may apply for amnesty first

Summary This chapter has examined a variety of issues related to the behavior of firms in oligopolistic industries such as: The Cournot (quantity) and Bertrand (price) models When firms choose prices and have differentiated products The infinite horizon extension of the Cournot model An exploration of antitrust law with respect to collusion (price fixing) The parallelism plus doctrine