Collusion and Price Competition

determines the competitive price, which is shown as a horizontal thin line. If all three sellers could set a price that maximized total earnings for the three of them, then they would each sell a single unit at a price indicated by the thick horizontal line in the graph.

Figure 16.1. Prices for a Session with No Collusion (Lower Sequence of Circles) and for a Second Session with Collusion (Upper Sequence of Squares)

Source: Davis and Holt (1996)

First consider a session in which buyers were taken from the room for value assignments, as in all sessions, but sellers were not permitted to fix prices.

The prices for this session are shown as the lower sequence in Figure 16.1. The circles are the list prices, and the units sold are shown as small dots which create a short horizontal line that begins in the circle and may extend to the right if more than two units are sold at this price. The prices for each period are separated by vertical lines, and the prices for the three sellers are shown in order from left to middle to right, for sellers S1, S2, and S3 respectively. Notice that the low-price firm sells the most units in the first two rounds, and that the other prices fall quickly. Prices are roughly centered around the competitive price in the later

periods. Sellers agreed on a common price in the 5th round, but all buyers made purchases for seller S1, which created an earnings disparity. Seller S1 then suggested that they take turns having the low price, and that he, S1, be allowed to go first! This agreement was adopted, and S1 made all sales in period 6. The low price position was rotated from seller to seller in subsequent rounds, much as the famous

“phases of the moon” price fixing conspiracy involving electrical equipment in the sixties. Notice that there was some experimentation with prices above and below the joint-profit-maximizing collusive level, but that prices stayed at approximately this level in most periods. This rotation scheme was quite inefficient, since each seller had a low-cost unit that would not sell when it was not their turn to have the low price. In other sessions with collusion, earnings were enhanced by agreeing to choose a common price and to limit sales to one unit each, thereby avoiding the inefficiencies caused by the rotation.

Figure 16.2. Prices for a Second Posted Offer Session with Collusion Source: Davis and Holt (1996)

Prices for a second session with collusion are shown in Figure 16.2. Again there is some price variability until sellers agree on a common price, this time in the fourth period. The failure of seller S2 to make a sale at this price forces them to deal

with the allocation issue, which is solved more efficiently by an agreement that each will limit sales to 1 unit. This agreement breaks down several periods later as S2, whose price is always listed in the center, lists a price below the others. A high price is reestablished in the final 6 periods, but prices remained slightly below the joint-profit-maximizing monopoly level. In two of these final periods, the sellers agreed to raise price slightly and hold sales to one unit each, but in each case S2 sold two units, leaving S3 with nothing. These defections were covered up by S2, who did not admit the extra sale, but claimed in the subsequent meeting that “this is economics,” and that there is less sold at a higher price. On both occasions, the others went along with this explanation and agreed to lower price slightly.

II. Collusion with Secret Discounts

Most markets of interest to industrial organization economists cannot be classified as continuous double auctions (where all price activity is public) or as posted offer markets (which do not permit discounts and sales). This raises the issue of how effective price collusion would be in markets with a richer array of pricing strategies and information conditions. In particular, markets for producer goods or major consumer purchases typically differ from the typical posted-offer institution in that sellers can offer private discounts from the "list" prices. The effectiveness of conspiracies in such markets is important for antitrust policy, since many of the famous price-fixing cases, like the electrical equipment bidding conspiracy discussed above, involve producer goods. Moreover, sales contracts and business practices that may deter discounts have been the target of antitrust litigation, as in the Federal Trade Commission's Ethyl case, where the FTC alleged that certain best-price policies deterred sellers from offering selective discounts. The anti-competitive nature of these best-price practices is supported by results of some experiments run by Grether and Plott (1984), who used a market structure that was styled after the main characteristics of the market for lead-based anti-knock gasoline additives that was litigated in the Ethyl case. Holt and Scheffman (1987) provide a theoretical analysis of best-price policies and of the experimental data reported by Grether and Plott.

In order to evaluate the effects of discount opportunities for the market structure considered in Figures 16.1 and 16.2, Davis and Holt (1996) ran a third series of sessions, in which sellers could collude as before, but when buyers returned and saw the sellers’ posted prices, they could request discounts. The way this worked was that a buyer whose turn it was to shop could either press a buy button

Prices were much lower in the collusion sessions with opportunities for discounting than in the collusion sessions with no such opportunities. In one session, one of the sellers got so mad at the others that she refused to speak with them in the discussion period between periods. Even in groups that maintained an active price-fixing discussion, the results were often surprising. Consider, for example, the price sequence in Figure 16.3. As before, the small squares indicate list prices, and the small dots indicate actual sales, often at levels well below posted list price. In period 3, for example, all sellers offer the same list price, but S1 sold two units at a deep discount. In periods 7 and 8, seller 2 began secret discounting, as indicated by the dots below the middle price square. These discounts caused S1 to have no sales in these periods, and S1 responded with a sharp discount in period 9 and a lower list price in period 10. After this point, discounts were pervasive, and the outcome was relatively competitive. This competitive outcome is similar to the results of several other sessions with discounting.

Figure 16.3. Prices for a Session with Collusion and Secret Discounts Source: Davis and Holt (1996)

One factor that hampered the ability of sellers to maintain high prices in the face of secret discounts is the inability to identify who is cheating on the agreement.