Cheating for $20: Why collusion and price fixing is difficult to do(freakonomics.blogs.nytimes.com)
freakonomics.blogs.nytimes.com
Cheating for $20: Why collusion and price fixing is difficult to do
http://freakonomics.blogs.nytimes.com/2009/10/22/cheating-for-a-20/
22 comments
It only takes one cheater for the collusive agreement to collapse.
True, and we do see this happen. Look at RAMBUS and SDRAM though it was a standards working group not a collusive group of price fixers.
There is something to be said for the consequences of breaking the agreement in the real world. In the classroom, she gets boo'd, but if she had been colluding with say 'the Mob' she might have to worry about something else after breaking the agreement.
This also doesn't take into account:
* Industries where the people at the top are part of an 'old boys club'
* An Industry were the conservative move is to collude and let the marketplace stagnate.
* In the classroom example, she had nothing to lose. She probably didn't even really care about the $20 or not. Whereas in the real world, people like guarantees. If a collusion agreement with players that you feel you can trust gets you a better guarantee than striking out on your own it's an attractive prospect.
* It could put a 'black mark' on you with other key players in your industry to play on their trust like that. Which could be a bad thing.
* This excludes collusion to to exclude a player. (e.g. the rumor that companies were going to break the FCC spectrum auction rules in an attempt to make sure that Google didn't get anything because it seemed that their plans were commoditize the industry.)
There is something to be said for the consequences of breaking the agreement in the real world. In the classroom, she gets boo'd, but if she had been colluding with say 'the Mob' she might have to worry about something else after breaking the agreement.
This also doesn't take into account:
* Industries where the people at the top are part of an 'old boys club'
* An Industry were the conservative move is to collude and let the marketplace stagnate.
* In the classroom example, she had nothing to lose. She probably didn't even really care about the $20 or not. Whereas in the real world, people like guarantees. If a collusion agreement with players that you feel you can trust gets you a better guarantee than striking out on your own it's an attractive prospect.
* It could put a 'black mark' on you with other key players in your industry to play on their trust like that. Which could be a bad thing.
* This excludes collusion to to exclude a player. (e.g. the rumor that companies were going to break the FCC spectrum auction rules in an attempt to make sure that Google didn't get anything because it seemed that their plans were commoditize the industry.)
Yup, repeat games are a different situation that may lead to different outcomes. If you can enforce the agreement, it's a different kind of game.
But then consider situations where information is unreliable:
- Cheating because you can't trust others not to cheat, i.e. to protect yourself, and everyone ends up cheating, as in Prisoner's Dilemma.
- In a lot of situations, you may not even know who is cheating and by how much, but you might be sure someone is cheating. This will feed back into your own incentives to cheat. I believe OPEC suffers from this a lot.
But then consider situations where information is unreliable:
- Cheating because you can't trust others not to cheat, i.e. to protect yourself, and everyone ends up cheating, as in Prisoner's Dilemma.
- In a lot of situations, you may not even know who is cheating and by how much, but you might be sure someone is cheating. This will feed back into your own incentives to cheat. I believe OPEC suffers from this a lot.
> In a lot of situations, you may not even know who is cheating and by how much, but you might be sure someone is cheating. This will feed back into your own incentives to cheat. I believe OPEC suffers from this a lot.
In situations like OPEC, it's also really different. You don't have everyone on an equal footing like in the classroom game.
If Venezuela can only produce 1 barrel/day and Saudia Arabia can produce 50 barrels/day, it doesn't matter how cheaply Venezuela prices their barrel. But oil is also a market where the appetite of the consumer severely outstrips availability. As long as you can produce large quantities of oil you can pretty much name your price (so long as that's large quantities in relation to other producers).
In situations like OPEC, it's also really different. You don't have everyone on an equal footing like in the classroom game.
If Venezuela can only produce 1 barrel/day and Saudia Arabia can produce 50 barrels/day, it doesn't matter how cheaply Venezuela prices their barrel. But oil is also a market where the appetite of the consumer severely outstrips availability. As long as you can produce large quantities of oil you can pretty much name your price (so long as that's large quantities in relation to other producers).
This is an example of one of the assumptions that break down very badly. In the real world, it usually doesn't take just one cheater for the agreement to break down, and the cheating is usually obvious to all participants, and results happen slowly (i.e., it's a repeat game scenario) rather than being a one-time event.
In other words collusion in the real world is MUCH easier than the scenario presented, and yet the students almost managed it anyway.
Suppose that the colluders are three (instead of eight) dominant telecom companies, who want to collude to keep cell phone prices high. Their prices are public knowledge, widely disclosed, and competitors can check each other on a daily basis. Market share - the prize - changes very slowly with changes in pricing - if you drop your prices 5 cents under your competitors, you may eventually win more market share, but it will happen veeeeeeeery slowly.
In this environment price collusion is easy to maintain indefinitely. It would almost be surprising if they weren't colluding.
In other words collusion in the real world is MUCH easier than the scenario presented, and yet the students almost managed it anyway.
Suppose that the colluders are three (instead of eight) dominant telecom companies, who want to collude to keep cell phone prices high. Their prices are public knowledge, widely disclosed, and competitors can check each other on a daily basis. Market share - the prize - changes very slowly with changes in pricing - if you drop your prices 5 cents under your competitors, you may eventually win more market share, but it will happen veeeeeeeery slowly.
In this environment price collusion is easy to maintain indefinitely. It would almost be surprising if they weren't colluding.
I am reminded of my favorite description of behavioral economics: "A field of academic inquiry into what college students will do when faced with making economic choices outside their personal experience."
It always cracks me up when I read a research paper with a new definite answer on human sexuality and find they used college kids as test subjects :-D
This is just a variation of a very interesting game Douglas Hofstadter describes in Metamagical Themas (extremely highly recommended by the way) in the section on psychological number games. In his game 10 people are allowed to choose "yes" or "no" without knowing what other people chose. If everyone picks "yes" everyone gets $100. If anyone picks "no" then anyone picking "no" gets $10 and everyone else get $0.
He describes inviting 10 of his friends he considers very smart, tells his friends they will be playing with other smart people, then expresses dismay when all his friends pick "no".
My sorry description here doesn't do the story justice. Very worth the time to track down a copy of the book.
He describes inviting 10 of his friends he considers very smart, tells his friends they will be playing with other smart people, then expresses dismay when all his friends pick "no".
My sorry description here doesn't do the story justice. Very worth the time to track down a copy of the book.
This boils down to asking "I'm going to put you in a room with ten peers. Do you believe at least one of your peers will either be irrational, or believe that a peer (possibly you) would be irrational?"
All ten people reached the correct conclusion!
All ten people reached the correct conclusion!
I think real life markets are much different than this experiment because:
1) Repeated trials in the game lets past loosers punish past winners (i.e. Ashley will get more than boos in subsequent trials).
2) Players get to observe the world better in real world than what secret bids in this game allows.
I am still unconvinced that collusion and price fixing is difficult as the title suggests.
1) Repeated trials in the game lets past loosers punish past winners (i.e. Ashley will get more than boos in subsequent trials).
2) Players get to observe the world better in real world than what secret bids in this game allows.
I am still unconvinced that collusion and price fixing is difficult as the title suggests.
OPEC, probably the most famous example of a cartel, is notorious for having members "cheat".
And yet they are completely capable of raising oil prices by merely sending out a press release or two.
They lost the ability in the 80s really. Too much non-Opec oil around now. And it hurt Opec in the long term as oil usage got much more efficient after the oil shocks
http://www.wtrg.com/opecshare.html
http://www.wtrg.com/opecshare.html
http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publicatio...
Alberta, on the other hand, might have some luck with a press release.
Alberta, on the other hand, might have some luck with a press release.
I think collusion depends on the amount in stake.
For e.g I think Intel, Microsoft & Cisco have colluded by not venturing into others business.
Wish that was true but in real life collusion is much easier to maintain. For example, a collusion deal usually entails higher prices which means that to benefit of cheating one has to lower prices and make money on volume.
But sometimes it is not as easy to make money on volume. Often you need time and capital investments to increase volume. But if the other colluding companies see you making the capital investments to get higher volume they will know you are planning to cheat and they will drop their agreement as well. At that point you get no sales advantage of cheating and yet you have spent a lot of money making to create the goods for an expected sales increase. Oh, and everyone else in industry hates your guts.
So sometimes in the real world it is much easier for an executive to collude and pocket his/her bonus than to compete.
But sometimes it is not as easy to make money on volume. Often you need time and capital investments to increase volume. But if the other colluding companies see you making the capital investments to get higher volume they will know you are planning to cheat and they will drop their agreement as well. At that point you get no sales advantage of cheating and yet you have spent a lot of money making to create the goods for an expected sales increase. Oh, and everyone else in industry hates your guts.
So sometimes in the real world it is much easier for an executive to collude and pocket his/her bonus than to compete.
I don't see how the example applies to all cases of price fixing.
If two gas stations next to each other decided to fix their price, and one all of a sudden decided to lower their price, then that would only give a temporary gain. If they stick to fixing the price however, they both will gain until a journalist muckrakes them.
Real world oil companies collusion http://www.cyprus-mail.com/news/main.php?id=48041 (was on holiday here and just read this in the paper version of the paper)
I played an identical game a few years ago. Someone went ahead and bid $100 for the $20. Models work fine as long as "rational" behavior is a worthwhile assumption.
Recent studies in behavioural economics (and also the winner of the Nobel in Economics a few years ago) suggest that rational isn't a necessary precondition - you just need some players who are rational/have knowledge. Sure it causes short term fluctuations but in the long run, you get to the same answer/price.
Was payout enforced? If they don't pay up, then the bidding could easily continue.
It reminds me of the RAND corporation experiment, an economist and a mathematician play the game and reach Nash Equilibrium in a handful of moves. Same game played by secretaries and they all co-operate all the time completely defying all of the theories they build up like a house of cards. So in an economy where everyone studies math for decades and has no social skills we have a great tool to predict the economy, but for most of the real world isn't much help.
Sure it can work in certain financial markets with no contact between participants outside the market mechanism and most of the players can be assumed reasonably expert, so it has its uses, but a lot of care needs to be used when trying to take it outside that sort of area because the assumptions break down very badly in most situations.