The Impact of Persistent Shocks and Concave Objective Functions on Collusive Behavior

Posted by D. Daniel Sokol

Johannes Paha (University of Giessen) discusses The Impact of Persistent Shocks and Concave Objective Functions on Collusive Behavior

ABSTRACT: The model proposed in this paper explains three stylized facts derived from case evidence: Cartel formation is more likely (i) when the industry has been hit by a negative profitability shock under the condition that (ii) this shock is rather persistent. (iii) This pattern is independent from the type of the shock, i.e. cost shocks, demand shocks etc. The paper analyzes the incentive for cartel formation when the industry switches between a good state with high profits and a bad state with low profits. The transition between states is modeled by a Markov-process that allows for transitory or persistent shocks. The decision maker incurs opportunity costs of collusion and chooses the conduct of a firm in order to maximize the present value of a concave objective function. The model shows that depending on the value of the opportunity costs and the discount factor collusion can be stable in no, one, or both states of the industry. When collusion is stable in only one state, this is the good state when industry conditions are transitory. When industry conditions are persistent, collusion is stable in the bad state.