topic 4 Flashcards
beyond the model of collusion: explain infinite horizons
Collusion is only sustainable if there are infinitely many periods - Otherwise, backward induction prevents it
In reality, no one faces an infinite horizon - Neither people nor firms last forever
Yet, it can provide a good approximation for two reasons
- Humans rarely compute backward induction more than a couple of steps ahead so, in practice, a long-enough horizon might suffice
- Managers may not know when things will end so as long as there is no end in sight, it might make sense to continue colluding
This might explain why CST Industries came forward to the CMA
- They might have perceived at some point that, one way or another, the collusive agreement was going to end
- Their horizon would have gone from infinite to finite
beyond the model of collusion: explain reaction time
How long does it take for a deviating firm to be punished?
- In the model: get one “period” of high profit before being punished
- How long that is depends on context
How about the agreement in the water tank industry?
- A firms might be able to “steal” a few contracts by bidding below the agreed amount
- But competitors would likely quickly catch on and exclude that firm from the agreement
- The ability to quickly identify and punish a deviating firm might explain why the agreement lasted for seven years
beyond the model of collusion: explain human factor
Managers may have developed relationships
- This often happens, especially in small industries
- They see each other do discuss other aspects of the industry, they may have previously worked or study together
Relationships can help sustain collusion
- You may not want to disappoint another manager with whom you have a relationship or are likely to interact in the future
- Can model this by having managers care not only about profit but also about whether collusion is sustained
This likely played a role in the water tanks industry
- Very niche industry, people are likely to know each other
- Creating such an elaborate collusion agreement requires some level of relationship/trust
- CST Industries’ decision to come forward could have resulted from a change of management
beyond the model of collusion: explain changes in conditions
The model assumes that all periods are identical
- Whatever is optimal in period 0 remains optimal forever
In reality, conditions change over time
- New firms enter, market conditions change, etc
Discount factors can also change
- For example, a manager who retires soon may be tempted to deviate
This can explain why collusion can end after some time
- In the water tank industry, something must have changed for CST Industries to put an end to the collusive agreement
what is a ‘Leniency Policy’
The goal is to provide firms with an incentive to deviate
- They avoid penalties they would suffer if a competitor deviated instead
It makes a collusive agreement very precarious
- You are constantly under the threat of a competitor ratting you out
This worked in the water tanks industry
- CST Industries did not deviate by lowering their price
- They deviated by contacting the CMA
- As a result, they avoided any punishment, only competitors were fined
