Public Policy in Private Markets

Collusion

Announcements

HW:

HW 1, still being graded HW 2, due 2/28 (posted); HW 3 due 3/6

3/6: first debate

3/8: midterm #1

Questions from last time

Price fixing fines

Whistleblower treatment – Leniency programs Leniency programs

Collusive Restraints of Trade

Practices covered by Section 1: Direct Agreements

To fix price To Allocate markets

Geographically By type of customer

Other Collusive restraints Gray area (circumstantial evidence) Conscious parallelism, trade associations, non-

profit organizations

Overcharges and the “but-for” price

Difficulties with calculation

Timing of conspiracy Conspiracy period v. Normal period?

Methodology for the but-for-price Cournot equilibrium price Cost-based pricing (Bertrand equilibrium?) Historical Forecasting

Collusive Restraints of Trade

Practices covered by Section 1: Direct Agreements

To fix price To Allocate markets

Geographically By type of customer

Other Collusive restraints Gray area (circumstantial evidence) Conscious parallelism, trade associations, non-

profit organizations

Other Collusive restraints

Price exchange agreements: Agreement to exchange price info (nothing else) Generally not ok: depends on market

circumstances (ATPCO case later today)

Trade Associations: Trade associations subject to scrutiny;

must be really careful

Other Collusive restraints

Conscious Parallelism: Tacit or indirect collusion (?) Parallel conduct:

Market where firms are charging same (or very similar) prices

Ambiguous: perfect collusion or perfect competition?

Not a decision rule: not illegal in and of itself

Illegality: conscious parallelism + facts

Conscious Parallelism

American Tobacco Case (1946) 3 companies dominated mkt: 1923-1941 Parallelism evidence:

8 price changes, 6 increases led by Reynolds, 2 decreases led by American

Facts: 2 coordinated price increases in face of slack

demand (i.e. when prices should have dropped)

“10-cent” cigarettes gain 25% of market: big cos. dropped prices until 10 cent cigarettes had 6% market share

Supplies were bought up by 3 firms, leaving competitors w/o supplies

Conscious Parallelism

American Tobacco Case (1946) Court found set of actions constituted

conspiracy “No formal agreement is necessary to

constitute an unlawful conspiracy”

Conscious Parallelism

Coke-Pepsi case (1980’s) Parallelism: Identical/similar prices and

promotional activities Factors:

Coordination for display space (who has bigger presence in which supermarkets)

Divided the year into exclusive promotional periods (e.g. Coke first 10 weeks, Pepsi next 10 weeks)

Respected each other’s promotional periods

Conscious Parallelism

Coke-Pepsi case Civil suit in Charlotte, NC (1986)

Federal case: local coke bottler conspired with Pepsi bottler to control prices and advertising promotions

Pepsi settled out of court Coke paid $2.7 mill

Conscious Parallelism

RTE cereal industry Parallel pricing moves:

1991: Quaker announces 5% increase, Kellogg and General Mills follow suit with 3.7% and 4%

Suspicious, but no other factors in this case

In practice: Conscious parallelism cases are very difficult Antitrust laws are usually not effective against

price leadership situations

Other Collusive restraints

The professions: Before 1970’s: professional associations had

provisions to restrict competition through advertising and price

Examples: “Suggested” fee schedule by Bar Association Ban on advertising, lawyers who advertise in Phoenix

disciplined by Bar Association (suspension) Others: dentists, optometrists, doctors

Justification: Restrictions needed to ensure quality, avoid deception

Supreme Court: rule of reason

Other Collusive restraints

Non-profit organizations: Justification: Restrictions necessary to protect

mission of the institutions Supreme Court: applies rule of reason Example: NCAA (1984)

Limits TV appearances by football teams (to increase attendance)

Courts: illegal, collusive restraint on “live college football TV”

What about now? players only get a scholarship (price fixing), while earning millions of $ for the university

Example: Ivy League Overlap Group (1984) – MIT case Agreed on financial aid packages (next week)

Industrial Organization

Weak Evidence of Price Fixing: ATPCO

What is ATPCO?

Airline Tariff Publishing Company (ATPCO) Owned by the airlines—sends price

change information to airlines and travel agents

At least once a day, ATPCO produces a compilation of all industry prices and sends it to the appropriate airlines and travel agents

How does ATPCO work?

ATPCO transmits a fare basis code (a “name” of the fare), the origin and destination airports, the price, the first and last ticket dates, the first and last travel dates, and any restrictions on the fare.

It grants almost perfect information to all firms in the market

Airline Tariff Case

Posting fares: Start and End sales date (future sales

date allows for “costless posting”) Fare codes (as footnotes) Start and End travel dates City-pair Restrictions (blackout dates, non-

refundable, etc.) It grants almost perfect information to all

firms in the market - monitoring is immediate and perfect

Airline Tariff Case

DOJ: System used as a signal mechanism:

Pre-announcement and communication: posting future price for future sale date. Iteration to an “agreed price” and exact dates

Coordination to protect more important markets (direct routes): fare codes used to send messages

Scheme might have cost $2B to consumers

Airline Tariff Case

DOJ: Airlines’ internal memos: “we are waiting to see if [carrier] is going

to go along with our proposed increase” “we are abandoning our increase on [city

1-city 2] because [carrier] has not matched”

“[carrier] is now on board for the [date] increase to [fare] on [city 1-city 2]”

Protecting direct routes

AA has hub in DFW Continental has hub in EWR

DFW

EWR

ATL

DET

DFW-ATL, AA: $200

DFW-ATL, CO: $100 (code ABC)

EWR-DET, AA: $50 (code ABC - from Mon till Wed)

EWR-DET, AA: $250 (start sale next Wednesday)

AA: I am undercutting you because you have a low price in DFW-ATL.I want you to increase your price to $250

$$ for CO

$$ for AA

Airline Tariff Case

DOJ: “The airlines used the ATP … system to

carry on conversations just as direct and detailed as those traditionally conducted by conspirators over the telephone or in hotel rooms. Although their method was novel, their conduct amounted to price fixing, plain and simple”

Airline Tariff Case

Why was this case difficult but important? No direct evidence of price fixing (price

exchange + conscious parallelism) Case appears as rule of reason

approach Outcome: Consent decree

Can not be used as precedent, BUT DOJ’s willingness to pursue difficult case sent a message

Industrial Organization

Weak Case of Price Fixing: School Mil

Ohio v. Trauth

Schools: Bid solicitation for annual supply of milk (sealed bid auction)

> 600 school districts Solicitation: menu of milk types,

sometimes with other requirements such as napkins, coolers.

Local diaries supplied milk Costs similar across diaries Distance is the key factor

Market concentration

Ohio v. Trauth

Homogeneous product Similar technology across processors Costly transportation (competition is localized) High barrier to entry (no one builds a plant solely

for selling milk to schools) Inelastic demand Infrequent demand Information available (schools posted info) Easy allocation of markets

Ohio v. Trauth

Methods involved complementary bidding: artificially raised the price for schools

Case where direct evidence was not enough: Additional economic (statistical) evidence was

needed Would a “control” group behave the way

defendants behaved? (i.e. probability and level of bids) Closeness should increase probability and size of bid

Are bids correlated? (complementary bidding)

Ohio v. TrauthControl group behavior

Accused firms behavior

Ohio v. TrauthAccused firms behavior

Ohio v. Trauth

Collusion is frequent in school milk auctions

130+ criminal cases filed