LECGE1330 Industrial Organization PDF

LECGE1330 – Industrial Organization 2. Regulation of competition Learning objectives Understand what influences the profitability and social desirability of horizontal mergers. Identify the incentives for firms to collude. Examine how competition authorities can fight collusion. Comp...

LECGE1330 – Industrial Organization 2. Regulation of competition Learning objectives Understand what influences the profitability and social desirability of horizontal mergers. Identify the incentives for firms to collude. Examine how competition authorities can fight collusion. Complementary readings Belleflamme & Peitz (2015). Industrial Organization: Markets and Strategies 2.A. Chapter 2 (2.3), Chapter 3 (3.2.2), Chapter 15 (15.1, 15.2, 15.3.3, 15.3.4) 2.B. Chapter 14 (14.1) 2.C. Chapter 14 (14.2, 14.3) Preliminaries Our running story 2 companies … sell “glints” … to a large mass of potential consumers ATREX BULVA 5 2. Regulation of competition A. Should we merge into a single firm? DECISIONS WITH NEGATIVE B. Should we form a secret cartel? IMPACTS ON C. Should we try to maintain high prices? CONSUMERS UNDER THE SCRUTINY OF COMPETITION AUTHORITIES ATREX BULVA 6 What are we talking about? https://www.youtube.com/watch?v=pDoNWPhRlWY 7 Objectives Previous module Positive approach → Explain the workings of imperfectly competitive markets This module Normative approach → Guidance for competitive policy Basic postulate: Competition is desirable, as it promotes economic efficiency Problem: Firms might be tempted to reduce competition Consequence: Set of rules aiming at maintaining competition European competition law TFEU – Article 101: Prohibition of agreements that reduce competition TFEU – Article 102: Prohibition of dominant position abuses + Merger control + State aids control 8 Market definition How do we set the contours of the relevant market? Identify the closest substitutes to the product under review. How? Hypothetical monopoly test Relevant market = Smallest product group such that a hypothetical monopolist controlling that product group could profitably sustain a Small and Significant Non- transitory Increase in Prices (SSNIP) Start with the narrowest definition (A) Can a hypothetical monopoly on A sustain a SSNIP? Yes? STOP THERE: A is the relevant market A No? INCLUDE CLOSE SUBSTITUTES ® B B Can a hypothetical monopoly on B sustain a SSNIP? C Yes? STOP THERE: B is the relevant market No? INCLUDE MORE SUBSTITUTES ® C, etc. 9 How do we assess market power? Definition of market power Ability to raise price above the perfectly competitive level. Measure 1. Lerner index (or markup) Difference between price and marginal costs as a 𝑝 − 𝐶′ 𝐿= percentage of the price 𝑝 Measure 1. Concentration indices Measures of the distribution of market shares. Define the market share of firm 𝑖 as 𝛼! ≡ (𝑞! ⁄𝑄)×100 Suppose there are 𝑛 firms in the market Order them by decreasing market shares. ! 𝑚-firm concentration ratio (𝑚 < 𝑛) 𝐼! = ( 𝛼" "#$ Herfindhal-Hirschman index % 𝐻𝐻𝐼 = ( 𝛼"& "#$ 10 https://www.higherrocked ucation.org/glossary-of- terms/herfindahl- hirschman-index-hhi- 11 What are mergers? Merger = Combination of 2 (or more) companies into a single entity Horizontal: Between competitors Vertical: Between companies at different stages of the supply chain Conglomerate: Between unrelated businesses Main effects Reduction of competition → Potential increase in prices Economic efficiencies → Potential decrease in prices + Dynamic (long-term) effects → Effects on innovation, consumer choice 12 Mergers. Key statistics Merger and acquisition deals 54,750 M&A deals globally in 2023 Total value of $3.1 trillion in 2023 13 Merger control European Merger Guidelines: Key Principles Notification Mandatory for mergers with "Community dimension” Based on turnover thresholds of involved companies Combined worldwide turnover > €5 billion EU-wide turnover > €250 million for at least two firms Types of Decisions Clearance /Prohibition/ Clearance with “remedies” Clearance with “remedies” in the majority of cases Remedies Assessment Criteria Usually structural Market definition Merger partners divest assets (manufacturing facilities, Competitive effects personnel, intellectual property) Efficiencies Goal: Prevent a merger from harming consumers By strengthening competitors or facilitating entry 14 Use of HHI in merger guidelines Source: Perplexity. 15 EU and National Merger control https://op.europa.eu/webpub/eca/speci al-reports/eu-competition-24-2020/en/ 16 Cartels and their detection https://www.youtube.com/watch?v=JO2R4Yort-g https://www.youtube.com/watch?v=QNu9os_HyMA 17 2.A Horizontal mergers 2.A. Horizontal mergers A. Should we merge into a single firm? DECISIONS WITH NEGATIVE B. Should we form a secret cartel? IMPACTS ON C. Should we try to maintain high prices? CONSUMERS UNDER THE SCRUTINY OF COMPETITION AUTHORITIES ATREX BULVA 19 What do we study in this section? 1. Effects of coordinated decisions 2. Mergers under quantity competition A. No impact on efficiency B. Impacts on efficiency C. Welfare analysis 3. Merger under price competition 20 What if firms coordinate their decisions? Suppose 3 firms in the market: Atrex (1), Bulva (2), and one other (3) Decisions: 𝑥" , 𝑥# , 𝑥$ → 𝜋! (𝑥" , 𝑥# , 𝑥$ ) Competition Each firm 𝑖 chooses its 𝑥! to maximize 𝜋! (𝑥" , 𝑥# , 𝑥$ ) ⇒ Each firm ignores the externalities it imposes on the other firms. Example: A change in 𝑥$ affects 𝜋& (𝑥$ , 𝑥& , 𝑥' ) and 𝜋' (𝑥$ , 𝑥& , 𝑥' ). Coordination Suppose firms 1 and 2 coordinate their decisions ⇒ They choose 𝑥" and 𝑥# to maximize 𝜋" (𝑥" , 𝑥# , 𝑥$ ) + 𝜋# (𝑥" , 𝑥# , 𝑥$ ) ⇒ They internalize the externalities they were imposing on one another. They also take into account the effects that 𝑥$ has on 𝜋& and that 𝑥& has on 𝜋$. 21 Impacts of coordinated decisions How do 𝑥0 and 𝑥1 change? → Depends on the sign of the externality %&! < 0 (negative externality): coordination → 𝑥" and 𝑥# ↓ %'" %&! > 0 (positive externality): coordination → 𝑥" and 𝑥# ↑ %'" How does 𝑥2 change? → Depends on the type of strategic interaction % %&$ < 0 (strategic substitutes) %'# %'$ → 𝑥$ moves in the opposite direction than 𝑥" and 𝑥# % %&$ > 0 (strategic complements) %'# %'$ → 𝑥$ moves in the same direction as 𝑥" and 𝑥# 22 Impacts of coordinated decisions (2) Quantity competition Price competition Negative externalities Positive externalities If one firm produces more, it If one firm sets a higher price, it negatively impacts the profit of positively impacts the profit of the other. the other. Strategic substitutes Strategic complements Reaction functions are Reaction functions are upward- downward-sloping; strategies sloping; strategies evolve in the evolve in opposite directions. same direction. ⇒ Firms 1 and 2 decrease their ⇒ Firms 1 and 2 increase their quantity when they coordinate. price when they coordinate. ⇒ Firm 3 reacts by increasing its ⇒ Firm 3 reacts by increasing its quantity. price. This reduces the benefits of This raises the benefits of coordination for firms 1 and 2. coordination for firms 1 and 2. 23 Impacts of coordinated decisions (3) Quantity competition Price competition ⇒ Firms 1 and 2 decrease their ⇒ Firms 1 and 2 increase their quantity when they coordinate. price when they coordinate. BAD FOR CONSUMERS BAD FOR CONSUMERS ⇒ Firm 3 reacts by increasing its ⇒ Firm 3 reacts by increasing its quantity. price. “LESS BAD” FOR CONSUMERS EVEN WORSE FOR CONSUMERS Other things equal, when competing firms coordinate their decisions, the negative impact on consumers is more significant under price competition than under quantity competition. 24 Reminder. Cournot model Consumer chooses the quantities 𝑞0 and 𝑞1 to maximize 1 1 𝑎 𝑞0 + 𝑞1 − 𝑞0 + 2𝑑𝑞0𝑞1 + 𝑞11 − 𝑝0𝑞0 − 𝑝1𝑞1 + 𝑦 2 FOCs give: 3 3 = 0 ⇔ 𝑎 − 𝑞0 − 𝑑𝑞1 = 𝑝0 and = 0 ⇔ 𝑎 − 𝑞1 − 𝑑𝑞0 = 𝑝1 34! 34" → Inverse demand functions: 𝑝0 𝑞0, 𝑞1 = 𝑎 − 𝑞0 − 𝑑𝑞1 3 𝑝1 𝑞0, 𝑞1 = 𝑎 − 𝑞1 − 𝑑𝑞0 0 ≤ 𝑑 ≤ 1 ⟶ Measures link between price and quantity of 𝑎 ⟶ Maximum price different goods ⟶ degree of consumer is willing to product substitutability pay for each good 𝑑 = 0 ⟶ independent goods 𝑑 = 1 ⟶ homogenous goods 25  Best-response functions max ⇡ (q1 , q2 ) = [p1 (q1 , q2 ) c 1 ] q 1 = (a c1 q1 dq2 ) q1 q1 First-order @⇡ (q1 , q2 ) = 0 , (a c1 q1 dq2 ) q1 = 0 condition @q1 1 max ⇡ (q1 , q2 ) = [p1 (q1 , q2 ) c 1 ] q 1 = (a c1 , q 1 = (a c1 q1dq2 ) ⌘ R1 (q2 ) 2 @R1 (q2 ) d @⇡ (q1, q2) = 0 , (a c1 q1 dq2) q1 =  0@q1 @q2 Firm 1’s best-response (or reaction) function 2 Downward-sloping ✓𝑞$ to choose◆to → Tells firm 1 which quantity 2⇡ q , q → If firm11 expects 𝑞& to increase, @ @⇡ maximize its profit, ( q , 1 2q ) @ ( 1 2 ) , q1it= (aby cdecreasing reacts 1 dq2 ) ⌘𝑞 R1 (q2 ) = = d  20 $ for any quantity 𝑞& that@q firm 2 2 could @q1choose @q1 @q2 @R1 (q2 ) d 1 = 0 q2 = (a c2 dq1 ) ⌘ R2 (q1 ) @q2 2 2 ✓ ◆ 26 @ @⇡ (q1 , q2 ) @ 2 ⇡ (q 1 , q 2 )  @R1 (q2 ) d = 0 Nash equilibrium @q2 2 ✓ ◆ @ @⇡ (q1 , q2 ) @ 2 ⇡ (q 1 , q 2 ) = = d0 We find firm @q 2’s2 best-response @q1 function @q1 @q2 in a similar way 1 q2 = (a c2 dq1 ) ⌘ R2 (q1 ) 2 Nash equilibrium = Intersection of best-response functions 𝑞"∗ , 𝑞#∗ such that 𝑞"∗ = 𝑅" (𝑞#∗ ) & 𝑞#∗ = 𝑅# (𝑞"∗ ) Equilibrium 1 2q1 = a c1 d (a c2 dq1 ) 2 , 4q1 = 2a 2c1 da + dc2 + d2 q1 , 4 d 2 q 1 = (2 d) a 2c1 + dc2 (2 d) a 2c1 + dc2 ⇤ , q1 = ⌘ q 1 4 d2 (2 d) a 2c2 + dc1 q2⇤ = 4 d2 27  n firms with di↵erent constant marginal cost ci, i = 1...n Extension to more than 2 firms Notation: Homogenous good (d = 1) Pn – Q = k=1 qk Assumptions 𝑛 firms with different constant marginal costs: 𝑐! Notation: – Q i = Q qi Homogenous product: 𝑑 = 1 Notation – Q= Pn – C i=C cP in k=1 qk – C= k=1 ck – Q i=Q qi Problem of firm ii: – C =C ci Problem of firm 𝑖:Pn max ⇡ i (qi , Q i ) = (a ci qi Q i ) qi – C= k=1 ck qi Problem of firm i: @⇡ i (qi , Q imax ) ⇡ i (q i , Q i ) = ( a ci q Q )q q= 0 i , (a c i q i Q i ) i qi =i 0 i @qi @⇡ i (qi , Q i ) 1 0 , (a = c q Q i) qi = 0 ,i qi = (a ci @q Qi i ) i (6) 2 1 28 , qi = (a ci Q i) (6) i (q i , Q i ) = 0 , (a ci qi Q i) qi = 0 @qi na C Nash 1equilibrium , q = (a c i Q ) i i (6) ,Q= n+1 ⌘ Q⇤ 2 1. Sum the best-response 2. Combine Developing (6) and (6) and using (7) (7) gives ver all n firms functions over all firms n X n X 2qi = a ci Q i =a ci Q + qi 1 qi = (a ci Q i) i=1 2 "i=1 # 1 X n n X n X na C ,Q= a ci Q , qi = a ci Q=a ci 2 i=1 i n+1 i=1 i=1 na ci C i n X , qi = a ci , 2Q = na C (Q qi ) n+1 i=1 na + a nci ci na + ci + C i n X n X , qi = n+1 , 2Q = na C Q+ qi i=1 i=1 a nci + C i , qi = ⌘ qi⇤ , 2Q = na C nQ + Q n+1 na C a+C i ,Q= ⌘ Q⇤ (7) qi⇤ 0,a nci + C i 0 , ci  n+1 n 29 , qi = a cina + a nc + ci + n + na 1i+ aci ncna c na C+ ici + C i , qi = , qi = i i = Nash equilibrium (2) na + a nci ci na + ci + C i n+1 n+1 a nci +a C nc i i + ⇤C i , qni + = 1 , qi = ⌘ qi ⌘ qi⇤ n+1 n+1 ✓✓ ◆2◆2 a nci + C i , qi⇤ 3.= Equilibrium ⌘ profit a + C ia + C i Symmetric ⇤ ⇤ firms i+ ⇤ a a ncnc C i i qi ⇡ ✓ = ( p ⇤ ⇤ c ) q ⇤ ⇤ = ◆ i+C qi 0 ,nqai+ nc ⇤ 10 i,+aC nc i i+ 0,C ici 0 , ci  i⇡ i = (p i ci )i q = i 2 n Competitive n ⇡ ⇤ = (p ⇤ c ) q ⇤ = a nc pressure i + C increases i n+ 1 1 nwith + ✓ ◆2 a + C na i CC a + C i number i i of firms.n⇤ + 1 a nc + C , a nci⇤ + C i p⇤⇤0=, c i na ⇤ C a + ⇡ ⇤ = ( p ⇤ c ) q = i i p = a Q =aa Q = an =n + 1 = n + 1 i i i n+1 n+1 n+1 If Ifci c= c for all i = 1... i = c for all i = 1... n, C = nc, C n, C = nc, C i = (n i = (n ⇤⇤ na a + C C a+ a C C i + ci + a Cnci + C i + = a Qp = cai = a C a + = cC = i + c i If c i = a c c nc for = i + all i = i 1... n,⇤ C = ⇤ nc, C ai a=nc n++ (nc (n1()nc.1)So 1c) c a a c ci = cnin=+ 1 +1 n+1 n+1 i n + 1 c = i If c = c for all qi qi== ⇤ p1...cn,= ⇤ cC == nc,nC+i 1= (n 1= ) c. So n + 1 ni + 1 i = p = i n+1 n c+ 1 n + n+1 C a + C i + ci a nci + C qi⇤ = p⇤ c = ⇤ a nc + ( na nc + = 1 ) c a (n✓ 1) c ◆ a c ci = ci = i qi = p ⇤ c = ✓ = 2◆2 1 n+1 n+1 n + 1 n +⇤ 1 n a+ 1c a cn + 1 ⇡ ⇤i⇡= ✓ ◆2 ✓ ◆2 ✓ i = ◆2n + n +11 a nci + C i ⇤ a ⇡c⇤ = a c ⇤ ⇡ i = (p ⇤ ⇤ ci ) q i = ⇡i = i n+1 n+1 n+1 Lerner Lernerindex index a ac c Lerner index p⇤p⇤ c c n+1 a ac c ci = c for all i = 1... n, C = nc, Lerner C i =index (n 1) c. So ⇤a c = = a+nc n+1 = = p⇤ c pn+1 p ⇤ a n+1 a+ncc a+ a +ncnc a nc + (n 1) c a c = a+nc = n+1 ⇤ ⇤ a c p⇤ c n+1 p ⇤ a c a + nc 30 qi = p c= = = a+nc = n+1 Mergers between several firms Model Demand: 𝑃 𝑞 = 𝑎 − 𝑞 (homogeneous product) 𝑛 firms with the same constant marginal costs: 𝑐 Cournot competition Suppose 𝑘 firms consider merging (with 2 ≤ 𝑘 ≤ 𝑛) Assumption: No efficiency gain After the merger, the merged entity continues to produce at cost 𝑐. ⇒ Firms are still symmetric after the merger Number of active firms Before the merger: 𝑛 After the merger: 𝑛 − 𝑘 non-merged firm + merged entity → 𝑛 − 𝑘 + 1 firms 31  When is the merger profitable? Compare Cournot equilibrium profits before and after the merger Profit of the Total profits of merged entity merging firms 𝑘 𝑘=𝑛 after before 𝑘 = 𝑘%&' ( 𝑘 = )* ' 𝑛 Slightly larger ! than "# 𝑛 32 When is the merger profitable? (2) “80% rule” Mergers between multiple symmetric Cournot competitors (and without any impact on efficiency) are only profitable if they involve at least 80% of the firms in the market. Intuition: Profitability depends on 2 opposite forces 1. By internalising the previous rivalry, the merged entity reduces the quantity produced, which increases its profit. 2. The outside firms react by increasing their quantity, which reduces the profitability of the merger. → The proportion of outside firms must be small enough ( 𝑘 = 2 → −(𝑛 − 2)& − 2 𝑛 − 2 + 1 = −𝑛& + 2𝑛 + 1 < 0 for all 𝑛 > 2 → NO 𝑛 = 𝑘 = 2 → 0 + 0 + 1 ≥ 0 → OK 56 Generalization to 𝒏 firms – Lesson Simultaneous formation of cartel Consider the formation of a single cartel on a Cournot market with homogeneous goods and constant marginal costs. If there are at least three firms in the industry, all firms remain independent. If there are just 2 firms in the industry, the 2 firms form a cartel. 57 Generalization to 𝒏 firms – Intuition “Better to be out than in” The formation of the cartel induces positive externalities on the firms outside the cartel (higher market price). All firms prefer to free-ride on the public good provided by cartel members. 58 Generalization to 𝒏 firms – Extensions Partial and stable cartels may form if … Firms produce horizontally differentiated goods Competition and free-riding incentive are relaxed. ® It is possible to find stable cartels comprising not all firms but a strict subset of them (if goods are sufficiently differentiated). Cartel is formed in a sequential way Firms can commit to stay out of the cartel. ® At equilibrium, first firms remain independent and free-ride on cartel that the last firms will eventually form. Stable cartels may exist! 59 Illustration of cartels’ instability 60 Illustration of cartels’ instability (2) 61 Detecting and fighting collusion Looking at possible high price-cost margins is not sensible ⇒ Evidence of wrongdoing must be found. Method 1. Direct investigation Communication is central to collusion. It might leave significant pieces of evidence Permanent records of meetings or agreements Telephone conversations may have been tapped. ⇒ This can be used to detect collusion. Method 2. Encourage informing Competition authorities have designed policies to encourage cartel members to bring evidence to the authorities. Leniency & Whistleblowing 62 Difficulties in detecting collusion 4 methods to detect collusion 1. Is the firm’s behaviour consistent or not with properties or behaviour that are supposed to hold under a wide class of competitive models? Screening 2. Are there structural breaks in the firm’s behaviour? 3. Does the behaviour of suspected colluding firms differ from competitive firm’s behaviour? If only a subset of firms in the industry colludes and they can be identified a comparison can be directly carried out. Verification Otherwise one can resort to comparison across markets and across periods. 4. Which model (competitive or collusive) better fits the data? 63 Difficulties in detecting collusion (2) All 4 methods suffer from 2 general problems. 1. Necessary data to identify firm’s behaviour are not available (cost is often unobservable). 2. Firms have an incentive to misreport private information. Authorities are likely to suffer from the so-called indistinguishability theorem ® Firms misreport cost information to make prices appear as resulting from competitive - and not collusive - behaviour + Problems of results interpretation Even if needed data are available, estimation of firm’s behaviour may be extremely sensitive to model specifications. 64 Leniency and whistleblowing programmes To obtain evidence for the existence of cartels and collusion, competition authorities introduced… Corporate leniency programmes Reduced sentences for firms that cooperate with the authorities and provide evidence for the existence of a cartel Whistleblowing programmes Shielding individual informants from criminal sanctions Results of law enforcement Make cartels less stable Break-up existing cartels Prevent the formation of cartels n - issio - c omm pean m/ euro rtel/ ia.co -ca ets med s-trading ark ond :/ / w ww.m -over-b s k http raboban fines - 65 2.C Tacit collusion 2.A. Tacit collusion A. Should we merge into a single firm? DECISIONS WITH NEGATIVE B. Should we form a secret cartel? IMPACTS ON C. Should we try to maintain high prices? CONSUMERS UNDER THE SCRUTINY OF COMPETITION AUTHORITIES ATREX BULVA 67 What is tacit collusion? ‘Meeting of the minds’ between colluding firms No explicit agreement, no communication The collusive outcome may emerge at the equilibrium of a non-cooperative game. The analysis of ‘tacit agreements’ is also highly relevant for explicit agreements. Cartels are inherently unstable (even when firms meet and discuss). Punishments cannot be legally binding. A cartel is more stable if collusion is individually rational for each member. 68  Tacit collusion is more challenging to detect Correlated price movements can give a hint. Example. Gas stations in Germany (2015) Price increases, usually started by Aral or Shell. If Aral begins, Shell follows in 90% of the cases after exactly 3 hours. Vice versa if Shell begins. Esso usually follows 3-6 hours after the first firm raised prices. Jet usually follows after 5h and sets a price of one cent per litre below the others. But parallel price movements are no proof! Why? Costs (e.g. crude oil) or demand (e.g., increases before holidays) might evolve similarly across firms. Competition authorities need hard evidence of price fixing (see 2.A) 69 See: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3795206 A model of tacit collusion Model 2 firms sell a homogenous good Cost of production: constant marginal cost 𝑐. At each period 𝑡 = 1, 2, … , 𝑇, firms repeat the same “static” game. Profits in the static game At the Nash equilibrium: 𝜋 % If both firms choose the collusive action, each firm gets 𝜋 + = 𝜋 ! /2. With 𝜋 % = monopoly profit If one firm chooses the collusive action and the other firm optimally deviates, this firms gets 𝜋 ) By definition: 𝜋 ) > 𝜋 + > 𝜋 % Example: Bertrand competition 𝜋 + = 𝜋 ! /2, 𝜋 ) ≅ 𝜋 ! , 𝜋 % = 0 70  Tacit collusion. Finite time horizon 𝑇 = finite number → Firms know when competition stops. We can use backward induction to determine the subgame-perfect equilibrium of the repeated game. Period 𝑇 → Firms play according to the Nash equilibrium of the static game; they obtain the corresponding profits. Period 𝑇 − 1 → The strategies firms choose don’t affect the future profits ⇒ They play according to the Nash equilibrium of the static game and obtain the corresponding profits (same as in 𝑇). And so forth up to Period 1. If competition is repeated over a finite number of periods, firms play according to the (unique) Nash equilibrium of the static game in each period. Tacit collusion cannot emerge. 71 See: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3795206 Tacit collusion. Infinite time horizon Firms don’t know when the competition will stop. Firms must always care about the future consequences of their current choices. → Some strategies may allow firms to sustain collusive outcomes over time. Example. Grim Trigger Strategy A firm starts by choosing the action that maximises total profits. It keeps on choosing this action as long as both firms have done so in all previous periods. ® “Cooperation phase” If one firm deviates, deviation ‘triggers’ the start of the “Punishment phase”. Firms choose the action that corresponds to the Nash equilibrium of the static game. 72 Tacit collusion. Infinite time horizon (2) When is the grim trigger strategy part of a SPE? At any period 𝑡, firm 𝑖 must find it optimal to play the strategy if it expects firm 𝑗 to play it as well. Period 𝑡 is in the punishment phase. Firm 𝑗 plays the Nash equilibrium action now and forever. ⇒ Firm 𝑖 can’t do better than playing this action as well. ⇒ Equilibrium Period 𝑡 is in the cooperation phase. Firm 𝑗 plays the collusive action. Trade-off for firm 𝑖 Immediate gain from deviation (𝜋 0 > 𝜋 3 ) Future losses due to firm 𝑗’s punishment (𝜋 + < 𝜋 3 ) Depends on: magnitude of 𝜋 0 − 𝜋 3 and 𝜋 3 > 𝜋 + + firm’s discount factor 73 Tacit collusion. Infinite time horizon (3) Period 𝑡 is in the cooperation phase (continued) Present discounted value if firm 𝑖 follows the grim trigger strategy: Present discounted value if firm 𝑖 deviates: Equilibrium (deviation is not profitable) if and only if Discounted long Short term term losses gain Firms have a sufficiently large discount factor (they put sufficient weight on future profits). 74 Tacit collusion. Infinite time horizon (3) Lesson If a competition game is repeated infinitely, any profit level between the Nash equilibrium profit and the monopoly profit can be supported in a subgame-perfect equilibrium if the discount factor is sufficiently large. Application. Bertrand competition 𝑛 ≥ 2 firms, constant and identical marginal cost Profits: 𝜋 S = 𝜋 T /𝑛, 𝜋 U ≅ 𝜋 T , 𝜋 E = 0 Tacit collusion can be sustained if and only if: The minimum discount factor is increasing in 𝑛. Tacit collusion is harder to sustain the larger the number of firms in the industry. 75 Factors facilitating tacit collusion What we already know Other factors Repeated competition over an Symmetric firms infinite horizon. It is harder for asymmetric firms to Tacit collusion cannot merge if “agree” on collusive prices or competition ends at some known production quotas. date. Frequent interaction High discount factors (patience) It makes deviation less profitable. Firms must value future profits Market transparency sufficiently to make the threat of Greater transparency makes it future punishment effective. easier to detect deviations and Small number of competitors trigger the punishment. The more numerous competitors Meet-the competition clauses are, the more patient they must Contractual commitments not to be. lower prices Also true under Cournot competition Most-favoured customer clause 76 Merger and tacit collusion Coordinated effects of mergers A merger may increase the incentives for the remaining firms to engage in tacit collusion. Contrasting impacts on the sustainability of collusion. The merger ¯ the number of firms in the market ® Tacit collusion becomes easier to sustain. The merger may increase the asymmetry among the remaining firms. ® Tacit collusion becomes harder to sustain. If synergies, the merged entity may become a more efficient producer than the outside firms. In differentiated goods industries, the merged entity may own a more extensive set of brands. 77 Merger and tacit collusion (2) This may affect the evaluation of merger remedies. Example. Nestlé-Perrier proposed merger Pre-merger Proposition 1 Proposition 2 Proposition 3 Perrier 36% Nestlé + 53% Nestlé + 38% Nestlé + Perrier Perrier Perrier -Volvic - Volvic - other brands BSN 23% Nestlé 17% BSN 23% BSN 38% + Volvic Others 24% Others 24% Others 24% Refused because Refused because dominant position coordinated effects Accepted 78 This work was made for you to share, reuse, remix, rework... It is licensed under the Creative Commons BY-NC-SA license to allow for further contributions by experts and users. Free-to-use photos from Pexels.com. Unlimited license on icons acquired from Noun Project You are free to share and remix/adapt the work. You may not use this work for commercial purposes. You must cite this document: You may distribute a modified work Belleflamme, P. (2024). LECGE1330 – Industrial under the same or similar license. Organization / Regulation of competition, Slide presentation, UCLouvain