| What is a cartel? | A cartel is a voluntary, written or oral agreement between independent private agents (companies) that determine jointly the value of their action parameters (eg prices or quantity), or divide the product market and customers (geographically) between themselves. Oligopolies are very prone to cartel formations, where the few large companies in the market collude and create a monopolly like situation. |
| What is the purpose of a cartel? | The overall objective of cartels is typically to ease the competitive pressures that normally exist in market situations through collective agreements that enable members to increase prices and profits above the competitive level. |
| What two forms can collusion take form of? | Collusion eliminates uncertainties of independent action and reduces complexities of interdependence – firms no longer need to speculate about likely reactions of rival firms. Collusion can take two forms:
1. Tacit: no formal agreement and direct communication.
2. Explicit: verbal and written agreements |
| How much more does consumers generally pay more as a consequence of a cartel, and how can counter factural pricing be used in the explanation? | On average, consumers pay 50% more when there is a cartel as opposed to normal market structure.
Counterfactual price: Estimate of price that would have emerged if there was no cartel. |
| What type of game theory can be used to explain a cartel? | Cartels can at times be explained by a cooperative game (as opposed to the usual game theory we have learned of a non-cooperative game) |
| What are the effects of cartels on economic welfare | The buyers pay a higher price consumer surplus goes to producer surplus Dead weight loss is created also as the price is higher than marginal cost. Hence, cartels reduce overall welfare and creates inefficient allocation of resources as we produce at lower MC than price (same issue as with monopoly). |
| What are the socio-economic effects of cartels? | • The speed of innovation in the industry may decrease as firms collaborate on price, market sharing and not competing with each other through innovations
• A recent good example of this is ’Dieselgate’ in Germany involving all big German car producers. Instead of investing in new (risky) technology they formed cartel and invested in (safe) ’old’ Diesel technology - and in software that deceived emission tests
• Firms’ productivity can go down, the ’quiet and comfortable life’ of the administration - and maybe in the production halls
• Lower innovation and enjoying ’business as usual’ imply higher costs (ATC and MC move upwards), even higher prices, losses in both consumer and producer surplus |
| What types of cartels (or collusive institutions) do we have? | 1. Cartels – associations of independent firms that restrain competition and exploit market power.
- Sales conditions; costs, prices and profit margins; allocation of territories or customers; productive capacity allocation. Pooling of such information make it easier for firms to co-ordinate pricing policies.
2. Trade associations – provide members with information on industry sales, productive capacity, creditworthiness of customers, etc
3. Joint ventures – association between two or more otherwise competing firms. Firms enter into joint ventures to:
- combine firm resource to increase efficiency
- overcome entry barriers and enter new markets
- develop joint research and development undertakings
4. Agreements on information exchange, e.g. info on Retail sales and market shares of each member at national, regional, county, dealer territory and postcode sector level for each model.
5. Semi-collusion – firms collude in some activities and compete in others
6. State-sponsored collusion – government imposes cartel conditions on firms |
| What are the motives of collusion? | 1. Profit maximization
- Higher profit by exercising (near monopoly) market power
2. Risk management and enhancement of security
- Risk arises from changes in consumer tastes and competition between producers
- Firms can choose to take independent actions (product differentiation, advertising and marketing) or collude and act jointly
3. Exchange of information
- It lowers firms’ vulnerability, encourages cooperative behavior and increases industry stability
4. Unsatisfactory performance
- Low profitability due to industry conditions such as intense competition and demand decline can encourage firms to collude |
| How is profits maximized in a cartel situation? | Assumptions:
• All firms in the industry are members of the cartel
• Each firm produces identical product
• Firms produce under a different cost structure
• No threat of entry
Profit is optimized much like in a monopoly situation. Output level at which marginal revenue (derived from industry average revenue function) equals industry’s marginal cost (sum of each firm’s marginal cost) function. |
| Why are cartels inherently unstable? | 1. In a game theory scenario, the firms often has an incentive to deviate. Hence, most cartels are not in a nash equilibirum! It is a prisoners dilemma, where if both act in their own self interest both lose.
2. Leniency reductions in fines from financial authorities. If one member of the cartel whistleblows, they get no fine. Hence, it is incentivised to inform authorities of the cartel.
3. Free rider problem. Free riders earn more than what cartel members do. |
| What is the free rider problem of oligopolies with a cartel? | The cartel will set a certain price by limiting the amount of products they produce to the market. However, freeriders (firms outside the cartel) are price takers, competing on price. Hence, they will produce more than the cartel members allow participating members to produce, earning a higher profit as freeriders captures the not serviced market who does not pay the cartel price. |
| What factors decide cartel stability? | • Seller concentration and number of firms – high concentration and small number of firms contributes to cartel stability
• Different goals of firms – conflicting objectives of members makes cartels unstable
• Process of cartel formation and assignment of quotas
• Non-price competition – significant opportunities for non-price competition makes cartels unstable
• Monitoring and detection of cheating – cartels are stable if there is effective mechanism of monitoring and detection of non-compliance
• Sanctions – ability of the cartel to impose punishment on non-compliance behavior increases chance of cartel stability
• Buyer concentration – lower buyer concentration facilitates cartel stability
• Fluctuations in demand
• Entry – profitability and stability of cartels depends on effective deterrence of entry by new firms
• Competition law – Leniency program. There is no fine for a firm if they blow the whistle on a cartel. |
| What factors play a role in cartel formation? | • Seller concentration and number of firms Small number of firms or high concentration facilitates collusion
• Cost functions Firms with similar cost structures enhances collusive behavior
• Size and product differentiation It is easier to collude when most firms are similar in their market share, size, product ranges, production technology and capacity
• Vertical integration It renders effective monitoring of cartel members difficult and thus may imped collusion.
• Transactions costs of collusion: costs of ensuring compliance and punishing non-compliant members:
- Ability to specify contractual relations correctly
- Extent to which agreement can be reached over joint gains
- Uncertainty associated with change in the economic environment
- Monitoring especially when there are non-price forms of competition
- Penalties particularly important in the absence of legal protection |
| How are cartels regulated? | Cartels in Denmark is regulated by The Danish Competition Act (DCA) which is harmonized with the treaty on the functioning of the European Union (TFEU). We will look at DCA:
§6 - It is not legal to create a cartel.
i. Fix purchase or selling prices or other trading conditions
ii. Share markets or sources of supply
iii. Undergo contracts that are accepted by agreeing to supplementary obligations with no relation to the contract.
iv. To determine binding resale prices or ensure partners do not deviate from a recommended resale price.
Overall, agreements that restrict competition are violations of §6. |
| What are the exemptions to regulation of cartel formation? | Exemptions to §6:
§7 - §6 does not apply if the firms involved have aggregate annual turnover of less than DKK 1 billion and an aggregate share of less than 10% of the market or an aggregate annual turnover of less than DKK 150 million
Important note re §7: price/quantity cartels are regarded as a hardcore violation of §6!
§8 - If the cartel provide better efficiency and provide consumers a fair share of the resulting benefits then §6 do not apply. Further, no unnecessary obligations or elimination of competition must happen. |
| What can competition authorities do about cartels? | 1. Prohibit the cartel
2. Competition authorities can hand over the cartel case to Special Economic and International Crime (SØIK) and creating a lawsuit.
- Penalties may be fines and/or prison up to 6 years.
Note: The Danish competition council is not the judicial authority in Denmark but may conclude voluntary settlement and fines for violation of DCA.
3. Competition authorities can receive a court order to raid a firm for information relating to the case (§18)
4. Granting leniency reductions for cartel members who whistle blow. |
| How are cartel fines computed in the EU? | See pic |
| What is the theory behind fines and leniency rules? | With fines, the likelihood of cartel formation becomes smaller due to greater risk and less expected returns.
Effect of leniency rules:
1. In theory, a firm might participate in a cartel to gain some benefit and then report it to the authorities. However, that is very risky and hence unlikely in practice.
2. The likelihood of the cartel being stable decreases as there is an incentive to report the rest of the cartel to the authorities. (See prisoners dilemma).
3. On the other hand, cartels might be stronger as other cartel members can sanction a cartel member.
4. Argument 2 is the most important in practice (The cartels becoming unstable) |
| What are the effects of increased transparancy on cartel stability? | Increased market transparency creates the following effects:
• Cartel members will find it easier to detect deviators
• At the same time, expected gain from deviation and loss after break-up becomes larger
• Deviations from cartels become less attractive as the gains from deviation decreases. Hence, increases market transparency can lead to more cartel formation.
However, there is a dilemma regarding this. Market transparency can increase on both the producer side (PT) and consumer side (CT). |
| What are the effects of transparancy on the producer side (PT)? | 1. Information of competitors’ prices, discounts, and capacity increases, making it easier to align interests and actions.
2. PT is a prerequisite for effective cartel agreements. It is easy to detect when a firm deviates from the cartel.
3. PT gives new entrants better market information and perhaps better competition, but increased PT makes it easier for the other firms to deter entry of new businesses limiting competition and creating DWL. |
| What are the effects of transparancy on the consumer side (CT)? | 1. The prerequisite for competition is that consumers respond to price and quality signals. The faster and stronger the consumer responds, the greater the incentive for the companies to compete on price and quality. Increase in CT implies that consumers are better informed and can respond faster and stronger to price and quality signals.
2. Implication for cartel formation: Increase in CT increases incentives for companies to break cartel agreements, for example - a big potential gain by lowering the price. With higher CT the market demand is more elastic, so consumers switch faster to the cheaper company. |
| Consumer side or producer side transparancy. What is better to combat cartel formations? and what is the dilemma of market transparency for competition authorities? | Overall, PT increases likelihood for cartel formations but CT decreases likelihood for cartel formations. However, there is an argument for CT leading to more cartels: CT could cause the counter-response by loyal cartel firms to create price war and use predatory pricing . Consumers would switch to the loyal cartel firms running smaller firms out of business, decreasing competition.
This creates the dilemma of market transparency for competition authorities: Can you increase consumer transparency (which in general has positive effects on competition) without increasing producer transparency (which in general has negative effects on competition through facilitating cartel formation)?
Rule of thumb: The more unfavorable market structure is for competition, the greater the risk that information sharing may harm competition. Ie focus on the ’usual suspects’ for cartel-promoting factors:
• High market concentration
• High entry barriers
• Homogeneous products
• Similar companies (same size, costs, etc.)
• Stable market development
• Regular demand
• Small, frequent orders |
| Describe a trade association | A trade association is generally a group of experts gathered to promote common interests and participate in public relations activities such as advertising, education, political donations, lobbying, and publishing, but their focus is Information exchange of trade associations means collecting, processing and retransmitting information and statistics to its members. Hence, trade associations create PT. This increases the risk of cartel-like conditions.
Recommendation for prices, discounts, limits, and disclosure of future price information is prohibited. All information must be confidential, meaning it should not be possible to know which firm the information comes from. Historical data might be OK if the information is unconfidently old and aggregated. |
