Tag: tacit collusion

Last year, an academic discovered that the only two firms on Amazon selling new copies of a classic biology textbook were charging well over $1 million (plus $3.99 for shipping!). Furthermore, when he checked the next day, prices had risen even further to nearly $2.8 million! Intrigued by this strange pricing behaviour, he started to investigate the prices further.

In oligopoly markets with a small number of players, firms must make strategic decisions taking into account how they expect their rivals will react. One option in today’s online market places is for firms to use computer algorithms which automatically adjust their prices according to the prices their rivals are charging. The results of his investigation suggested that this was exactly what was causing the prices for this textbook to be so high.

One of the firms appeared to adopt a pricing rule which set its price at 0.9983 times the price of the other firm. This seems to make sense – this firm wants to undercut its rival in order to be more likely to sell its copy. However, if both firms operated under this strategy, we would expect to see prices falling over time (see also). In contrast, the strategy of the other firm appeared to be to price 1.270589 above its rival’s price. Why would it want to try to make sure it was always more expensive that its rival? The academic’s plausible explanation was that:

“…they do not actually possess the book. Rather, they noticed that someone else listed a copy for sale, and so they put it up as well – relying on their better feedback record to attract buyers. But, of course, if someone actually orders the book, they have to get it – so they have to set their price significantly higher – say 1.27059 times higher – than the price they’d have to pay to get the book elsewhere.”

Put both of these pricing rules together and prices will continuously rise over time! This was exactly what the academic observed for over a week, until human intervention appears to have returned prices to a more sensible level.

As Tim Harford discusses in his recent blog post, it had been hoped that online market places would result in very low prices because the high degree of price transparency increases competition. Clearly the prices Amazon was initially charging for the textbook didn’t support this theory and even after human intervention prices would seem to be well above marginal production costs. However, as the blog post goes on to explain, we should not necessarily expect price transparency always to lead to low prices. Economic theory shows us that in oligopoly markets, when a small number of players interact repeatedly, they may be able to collude tacitly on high prices. Furthermore, a high degree of price transparency may help such collusive behaviour because it makes it easier for firms to detect cheating by a rival.

Amazon’s $23,698,655.93 Book About Flies (SCREENSHOT) The Huffington Post, Steven Hoffer (26/04/11)

Questions

  1. What are the key features of competition between book sellers on Amazon?
  2. What price setting rule would the two firms have to use for prices to continuously fall over time? Provide an illustrative example.
  3. What are the pros and cons for a firm of relying on a computer algorithm to set its prices?
  4. How might a firm program its price setting algorithm if it wanted to collude tacitly with its rivals?
  5. Can you think of any other explanations for the pricing strategies that the two Amazon sellers adopted?

Last week, I posted an article about a price discriminating tactic in operation by a few firms, whereby they were charging different prices to different consumers, depending on whether or not people could speak the language. (See Entrance this way!). Following this, I had a look around to find some other pricing strategies in practice by firms. These ranged from simple price discrimination to a well-known supermarket, which, following the failure of its till system, decided to trust consumers: estimate the value of the goods in your trolley/basket, deduct 20% and that’s the amount you pay. Also, a strategy being adopted by a number of restaurants – ‘pay what you think it’s worth!’ An advertising gimmick that increased sales.

So, what’s the best pricing strategy for a firm to adopt and which factors affect this? Is it really a rational decision to offer meals, with the possibility that the guests may only be prepared to pay 1p?!

You decide how much meals are worth, restaurants tell customers Telegraph, Nina Goswami (12/06/05)
Panera café says pay what you want Associated Press, Food Inc, Christopher Leonard (18/5/10)
Pound shop forced to close after 99p store opens across the road Daily Mail Online (12/1/09)
Low cost? Not with these extras Times Online, Richard Green (17/8/08)
Cheap hotels: budget accommodation for visits to London Telegraph (25/10/10)
Budget customers call the hotel Tune BBC News, Susannah Streeter (30/8/10)

Questions

  1. Is it a rational decision to trust consumers and ask them to estimate the value of what’s in their trolleys?
  2. Why would a restaurant offer consumers the chance to pay ‘what you think it’s worth’? Under what circumstances would this incrrease the firm’s revenue?
  3. What are the key factors that determine the price a firm will charge for its product?
  4. How can we use the case in Poole, with the new 99p shop, to analyse the model of perfect competition?
  5. What pricing tactic is being used by the 99p shop? How could we argue that this is an example of tacit collusion?

You might think that small environmentally-friendly companies would be moving into the green energy market: that setting up a wind farm, for example, would be a perfect business opportunity for a small company. In fact, the big companies are taking over this market. As the Der Spiegel article below states:

Europe’s wind energy sector is currently experiencing a major transformation. New massive offshore wind parks are soon expected to crop up off Europe’s coastline. Big companies like Siemens and General Electrics are increasing their stakes in a market worth billions. But experts warn that a new energy oligopoly may soon emerge.

So what is it about the wind energy market that makes it suitable for an oligopoly to develop? The two articles explore this question.

Winds of Change Der Spiegel, Nils-Viktor Sorge (1/11/10)
GE and Siemens Outpacing Wind Pioneers, Becoming Clean Energy’s “New Oligopoly” Fast Company, David Zax (2/11/10)

Questions

  1. What market failures are there in the wind energy market?
  2. What barriers to entry are there in the wind energy market?
  3. What economies of scale are there in this market?
  4. How are changes in this market affecting the minimum efficient scale of companies?
  5. Would there be room in the market for enough competitors to prevent collusion?
  6. How might the authorities prevent (a) open and (b) tacit collusion in the wind energy market?
  7. Do small wind energy companies have any market advantages?