Tacit collusion
Encyclopedia
Tacit collusion
occurs when cartels are illegal or overt collusion is absent. Put another way, two firms agree to play a certain strategy without explicitly saying so. Oligopolists
usually try not to engage in price cutting, excessive advertising or other forms of competition. Thus, there may be unwritten rules of collusive behavior such as price leadership (tacit collusion). A price leader will then emerge and sets the general industry price, with other firms following suit. For example see the case of British Salt Limited and New Cheshire Salt Works Limited.
Tacit collusion is best understood in the context of a duopoly
and the concept of Game Theory
(namely, Nash Equilibrium
). Let's take an example of two firms A and B, who both play an advertising
game over an indefinite number of periods (effectively saying 'infinitely many'). Both of the firms' payoffs are contingent upon their own action, but more importantly the action of their competitor. They can choose to stay at the current level of advertising or choose a more aggressive advertising strategy
. If either firm chooses low advertising while the other chooses high, then the low-advertising firm will suffer a great loss in market share while the other experiences a boost. However if they both choose high advertising, then neither firms' market share will increase but their advertising costs will increase, thus lowering their profits. If they both choose to stay at the normal level of advertising, then sales will remain constant without the added advertising expense. Thus, both firms will experience a greater payoff if they both choose normal advertising (however this set of actions is unstable, as both are tempted to defect to higher advertising to increase payoffs). A payoff matrix is presented with numbers given:
Notice that Nash's Equilibrium is set at both firms choosing an aggressive advertising strategy. This is to protect themselves against lost sales.
In general, if the payoffs for colluding (normal, normal) are greater than the payoffs for cheating (aggressive, aggressive), then the two firms will want to collude (tacitly).
are able to extract optimum revenue by offering fewer units at a higher cost.
An oligopoly where each firm acts independently tends toward equilibrium
at the ideal, but such covert cooperation
as price leadership tends toward higher profitability for all, though it is an unstable
arrangement.
In barometric firm price leadership, the most reliable firm emerges as the best barometer of market conditions, or the firm could be the one with the lowest costs of production, leading other firms to follow suit. Although this firm might not be dominating the industry, its prices are believed to reflect market conditions which are the most satisfactory, as the firm would most likely be a good forecaster of economic changes.
Collusion
Collusion is an agreement between two or more persons, sometimes illegal and therefore secretive, to limit open competition by deceiving, misleading, or defrauding others of their legal rights, or to obtain an objective forbidden by law typically by defrauding or gaining an unfair advantage...
occurs when cartels are illegal or overt collusion is absent. Put another way, two firms agree to play a certain strategy without explicitly saying so. Oligopolists
Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
usually try not to engage in price cutting, excessive advertising or other forms of competition. Thus, there may be unwritten rules of collusive behavior such as price leadership (tacit collusion). A price leader will then emerge and sets the general industry price, with other firms following suit. For example see the case of British Salt Limited and New Cheshire Salt Works Limited.
Tacit collusion is best understood in the context of a duopoly
Duopoly
A true duopoly is a specific type of oligopoly where only two producers exist in one market. In reality, this definition is generally used where only two firms have dominant control over a market...
and the concept of Game Theory
Game theory
Game theory is a mathematical method for analyzing calculated circumstances, such as in games, where a person’s success is based upon the choices of others...
(namely, Nash Equilibrium
Nash equilibrium
In game theory, Nash equilibrium is a solution concept of a game involving two or more players, in which each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only his own strategy unilaterally...
). Let's take an example of two firms A and B, who both play an advertising
Advertising
Advertising is a form of communication used to persuade an audience to take some action with respect to products, ideas, or services. Most commonly, the desired result is to drive consumer behavior with respect to a commercial offering, although political and ideological advertising is also common...
game over an indefinite number of periods (effectively saying 'infinitely many'). Both of the firms' payoffs are contingent upon their own action, but more importantly the action of their competitor. They can choose to stay at the current level of advertising or choose a more aggressive advertising strategy
Strategy
Strategy, a word of military origin, refers to a plan of action designed to achieve a particular goal. In military usage strategy is distinct from tactics, which are concerned with the conduct of an engagement, while strategy is concerned with how different engagements are linked...
. If either firm chooses low advertising while the other chooses high, then the low-advertising firm will suffer a great loss in market share while the other experiences a boost. However if they both choose high advertising, then neither firms' market share will increase but their advertising costs will increase, thus lowering their profits. If they both choose to stay at the normal level of advertising, then sales will remain constant without the added advertising expense. Thus, both firms will experience a greater payoff if they both choose normal advertising (however this set of actions is unstable, as both are tempted to defect to higher advertising to increase payoffs). A payoff matrix is presented with numbers given:
| Firm B normal advertising | Firm B aggressive advertising | |
|---|---|---|
| Firm A normal advertising | Each earns $50 profit | Firm A: $0 profit Firm B: $80 profit |
| Firm A aggressive advertising | Firm A: $80 profit Firm B: $0 profit |
Each earns $15 profit |
Notice that Nash's Equilibrium is set at both firms choosing an aggressive advertising strategy. This is to protect themselves against lost sales.
In general, if the payoffs for colluding (normal, normal) are greater than the payoffs for cheating (aggressive, aggressive), then the two firms will want to collude (tacitly).
Forms
Classical economic theory holds that price stability is ideally attained at a price equal to the incremental cost of producing additional units. MonopoliesMonopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
are able to extract optimum revenue by offering fewer units at a higher cost.
An oligopoly where each firm acts independently tends toward equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
at the ideal, but such covert cooperation
Collusion
Collusion is an agreement between two or more persons, sometimes illegal and therefore secretive, to limit open competition by deceiving, misleading, or defrauding others of their legal rights, or to obtain an objective forbidden by law typically by defrauding or gaining an unfair advantage...
as price leadership tends toward higher profitability for all, though it is an unstable
Instability
In numerous fields of study, the component of instability within a system is generally characterized by some of the outputs or internal states growing without bounds...
arrangement.
In barometric firm price leadership, the most reliable firm emerges as the best barometer of market conditions, or the firm could be the one with the lowest costs of production, leading other firms to follow suit. Although this firm might not be dominating the industry, its prices are believed to reflect market conditions which are the most satisfactory, as the firm would most likely be a good forecaster of economic changes.
See also
- Cournot competitionCournot competitionCournot competition is an economic model used to describe an industry structure in which companies compete on the amount of output they will produce, which they decide on independently of each other and at the same time. It is named after Antoine Augustin Cournot who was inspired by observing...
- WhistleblowerWhistleblowerA whistleblower is a person who tells the public or someone in authority about alleged dishonest or illegal activities occurring in a government department, a public or private organization, or a company...
- Nash EquilibriumNash equilibriumIn game theory, Nash equilibrium is a solution concept of a game involving two or more players, in which each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only his own strategy unilaterally...
- Competition LawCompetition lawCompetition law, known in the United States as antitrust law, is law that promotes or maintains market competition by regulating anti-competitive conduct by companies....