Question

Explain whether the following make collusion more or less likely and why.

a) Higher interest rates

b) Less frequent interaction between competitors

c) Growing profits in the industry

d) A firm on the verge of bankruptcy

e) A new competitor entering the market

Answer 1

a)

Collusion is sustainable if and only if firms put sufficient weight on future profits, i.e., if their discount factor is not too small.

For a larger , meaning for a small collusion is sustainable.

Hence higher the interest rates, less likely is the collusion.

b)

Collusion is easier when firms interact more frequently. This keeps a transparency and helps them monitor the quantity produced by members of the cartel to make sure that no one is deviating.

Hence less frequent interaction between competitors makes collusion less likely.

c)

Collusion is easier in growing markets (taking as given the number of competitors, that is, ignoring the possible positive effect of demand growth on entry) than in declining markets and in stable markets than in fluctuating markets. These factors are useful to assess the seriousness of the collusion concern.

d)

A firm on the verge of bankruptcy has incentive to cheat in collusion and make larger profits for a short period because it knows that it is not going to last in the long run anyway.

e)

Collusion is more of a concern in markets with high entry barriers. The successful entry of non-cartel firms into the industry undermines a cartel’s control of the market and hence collusion is less likely.