On the Stability of Collusion

Abstract

The literature on oligopolistic competition abounds with various implicit statements about the ‘stability’ of collusive arrangements. A well known example is provided by comments on price arrangements between the sellers in a given industry. It is asserted that any oligopolistic configuration must be unstable with respect to monopolistic collusion: ‘the combined profits of the entire set of firms in an industry are maximised when they act together as a monopolist, and the result holds for any number of firms’ (Stigler, 1950, p. 24). At the same time however, it is recognised that ‘when the group of firms agrees to fix and abide by a price approaching monopoly levels, strong incentives are created for individual members to chisel — that is, to increase their profits by undercutting the fixed price slightly, gaining additional orders at a price that still exceeds marginal cost’ (Scherer, 1980, p. 171). On the other hand, in the recent literature on the core of an exchange market, it has been shown that, sometimes, monopolistic collusion can be disadvantageous to the traders involved when compared to the competitive outcome (Aumann, 1973). As for the collusive price-leadership model, it is stressed that the outsiders of a merger agreement may be better off than the insiders:

the major difficulty in forming a merger is that it is more profitable to be outside a merger than to be a participant. The outsider sells at the same price but at the much larger output at which marginal cost equals price. Hence the promoter of a merger is likely to receive much encouragement from each firm — almost every encouragement, in fact, except participation (Stigler, 1950).

We are grateful to A. Shaked for his comments and suggestions.