Cartels and tacit collusion

Question 1

What does it mean if a firm were to collude or price fix?

Answer 1

The firms avoid competing with one another

Question 2

Why is collusion said to be tacit?

Answer 2

Because firms non-cooperatively adopt strategies that lead to a coordinated outcome

Question 3

True or False:

There is a consensus that collusive agreements are welfare-reducing and should therefore be forbidden

Answer 3

True

Question 4

What are the two important aspects of collusion discussed in this chapter?

Answer 4

Cartel formation and the stability of such cartels, including their optimal and equilibrium size.

Question 5

How can collusion be sustained without binding agreements?

Answer 5

Collusion can be sustained as the non-cooperative equilibrium of repeated competition, leading to a tacit understanding among firms on how to behave in a coordinated way without explicit agreements.

Question 6

Why is tacit collusion of particular importance for firms?

Answer 6

Tacit collusion is important because while explicit cartels are illegal, firms can still implicitly coordinate, understanding how other firms will react to their behavior without binding agreements

Question 7

What is the main issue with tacit collusion?

Answer 7

Determining the sustainability of tacitly agreed-upon prices within a non-cooperative equilibrium when competition is repeated over time.

Question 8

What lesson does the vitamin cartel case provide about the potential risks and consequences of corporate collusion?

Answer 8

It demonstrates that while cartels may offer short-term profits for companies, the long-term risks and consequences including fines, legal costs, reputational damage, and potential imprisonment for executives, are severe.

Question 9

What effect does the formation of a cartel have on competition within an industry?

Answer 9

They eliminate the competition between them, leading to reduced joint output or increased prices.

Question 10

Why might cartels be considered unstable?

Answer 10

because firms outside the cartel might benefit from the collusive behaviour, leading them to free-ride on the efforts of the cartel, and the stability of a cartel depends on the institutional procedures that govern its formation.

Question 11

What are the three procedures contrasted in the study of cartels?

Answer 11

1) Firms deciding simultaneously to participate in a single industry-wide cartel with open membership

2) The endogenous formation of multiple cartels with exclusive membership

3) bilateral market-sharing agreements that create a collusive network.

Question 12

How does the first procedure of cartel formation differ from the second?

Answer 12

In the first procedure, cartel membership is open and firms cannot exclude others from joining. In the second, cartels form sequentially with exclusive membership, and each firm’s decision influences subsequent actions.

Question 13

What characterises the third procedure of cartel formation?

Answer 13

The third procedure relies on bilateral market-sharing agreements, where pairs of firms refrain from competing in each other’s territories, thus forming a collusive network.

Question 14

What market structure is used to compare the three cartel formation procedures?

Answer 14

The comparison is made in a market structure where symmetric firms produce a homogeneous good at a constant marginal cost, competing à la Cournot with an inverse demand function P=a−q, where q is the total quantity produced.

Question 15

Tacit collusion analysis is highly relevant for explicit agreements, true or false?

Answer 15

True

Question 16

Under simultaneous cartel formation, do firms have an incentive to leave the cartel?

Answer 16

Yes, due to the free riding effect

Question 17

When firms produce horizontally differentiated goods, is the free riding effect larger or smaller than if they were to produce homogeneous goods

Answer 17

Smaller, as competition is relaxed

Question 18

True or false:

If goods are sufficiently differentiated, it is possible to find stable cartels comprising not all firms but a strict subset of them

Answer 18

True

Question 19

What is the ‘80% rule’ in the context of cartel formation?

Answer 19

The ‘80% rule’ states that in the equilibrium of the sequential cartel formation game, at most one cartel will form, comprising more than 80% of the firms in the industry, while the rest remain independent.

Question 20

What does sequential cartel formation allow for in terms of cartel structure?

Answer 20

Sequential cartel formation allows for the endogenous formation of multiple cartels with exclusive membership, where firms take a forward-looking approach in deciding whether to join a cartel.

Question 21

How does product differentiation affect the formation and stability of a cartel?

Answer 21

Product differentiation relaxes competition and thus reduces the free-riding incentive, making it more feasible for cartels to form and remain stable.

Question 22

What is the main result from the section on single cartel formation on a Cournot market with homogeneous goods?

Answer 22

The main result is that in a Cournot market with homogeneous goods and constant marginal costs, no cartel is stable unless there are only two firms, due to the strong free-riding incentive.

Question 23

Why can the formation of a cartel be seen as a public good?

Answer 23

The formation of a cartel can be seen as a public good because it eliminates competition between firms, leading them to reduce their joint output or to increase their prices, which benefits all firms even those outside the cartel due to the higher market price.

Question 24

How is a horizontal merger related to cartel formation?

Answer 24

A horizontal merger can be seen as a cartel requiring the unanimity of its members, as both involve firms coordinating to act as a single entity in the market.

Question 25

True or false:

In a simultaneous cartel formation, any firm has incentive to leave the cartel

Answer 25

True!

Question 26

True or false:

In a sequential formation, the first firm can commit to stay out the cartel, making it possible for a cartel to form at equilibrium

Answer 26

True

Question 27

What is a strategy defined as?

Answer 27

A list of actions (a contingent plan) that tells the firm what to choose in each period as a function of past prices or quantities (that is, the history of the game)

Question 28

True or false:

Anything said about tacit collusion is relevant for explicit collusion

Answer 28

True

Question 29

What happens initially under the Grim Trigger Strategy?

Answer 29

The first firm chooses the action that maximises total profits (price at monopoly level)

Question 30

What is the trade-off between in the Grim Trigger Strategy?

Answer 30

The immediate gain from deviation and future losses resulting from the other firms punishment

Question 31

What does the Grim Trigger Strategy trade-off depend on?

Answer 31

The magnitude of the deviation and the punishment profits wrt collusive profits and the firms discount factor

Question 32

What is a crucial element to support collusion?

Answer 32

The discount factor because the grim trigger strategy relies on firms valuing future profits highly enough to deter them from seeking an immediate gain from cheating on the cartel agreement.

Question 33

Under the grim trigger strategy, if any one firm deviates from this agreement (by, say, undercutting the agreed-upon price), what happens to all other firms?

Answer 33

They will revert to non-cooperative behaviour indefinitely

Question 34

What does the discount factor represent?

Answer 34

The present value of future earnings

Question 35

.If firms discount future profits heavily (implying they place a higher value on immediate profits), the threat of future punishment is less effective, and the grim trigger strategy may not support collusion

Answer 35

True

Question 36

True or False:

Tacit collusion is not possible when competition is repeated over a finite number of periods

Answer 36

True

Question 37

What does it mean if collusion is reached in a ‘Tacit’ way?

Answer 37

Firms do not necessarily resort, for example to explicit quota agreements to discipline collusion

Question 38

What do we mean if firms are competing with an infinite horizon?

Answer 38

There is no end date to the game, after each period there is a probability that firms will compete one more time

Question 39

what does the discount factor lie strictly between?

Answer 39

0 and 1, if players are patient then discount factor will be closer to 1

Question 40

When is it possible to support collusion under the grim trigger strategy?

Answer 40

Depends on whether the payoff from cooperation is no smaller than the payoff from deviating

Question 41

Is collusion harder or easier to maintain across multimarket industries? Why?

Answer 41

Easier because the frequent interactions between the same firms in multiple markets create a mutual dependency. This interdependence enhances the ability to monitor and enforce collusive agreements, as firms can retaliate across different markets if one party deviates, thereby increasing the overall cost of defection and stabilizing the collusion.

Question 42

Why is collusive pricing difficult to maintain in one-period competitions but easier in multi-period interactions?

Answer 42

Collusive pricing is challenging in one-period competitions because there’s no future interaction to consider, encouraging firms to maximize immediate profits without fear of retaliation, while in multi-period interactions, the ongoing nature of competition discourages deviations from collusive agreements due to the threat of future retaliation and the potential for sustained higher profits, promoting stable and cooperative pricing strategies over time.