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:  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. Trauth Control group behavior Accused firms behavior

Ohio v. Trauth Accused firms behavior

Ohio v. Trauth Collusion is frequent in school milk auctions 130+ criminal cases filed