Question

Suppose there are four large manufacturers of toilet tissue. The largest of these manufacturers announces that it will raise its prices by 15 percent due to higher paper costs. Within three days, the other three large toilet tissue manufacturers announce similar price hikes. Would this decision to raise prices be evidence of explicit collusion among the four companies? Briefly explain.

Short answer

Based purely on the presented information, the simultaneous price increases does not definitively prove explicit collusion among the four toilet tissue manufacturers. This is because the other firms may have just followed the price leader. The evidence of explicit collusion would require proof of a planned agreement between the firms.

Step-by-step solution

Understanding Explicit Collusion

Explicit collusion is generally considered as a situation where companies plan together to fix prices, divide markets or rig bids. This collusion usually takes place in an oligopolistic market (market with few sellers), where the sellers realize they can benefit more by cooperating with one another, rather than competing.

Analyzing the Scenario

By looking at the scenario, the largest manufacturer among the four decided to increase their prices. Following that, the other three also increased their prices. However, there is no evidence that the companies had a prior agreement to raise prices simultaneously.

Conclusions

Based on the given info, it is not certain if there was explicit collusion among the manufacturers. Their actions could also be explained by implicit collusion (or price leadership) where other manufacturers followed the price leader. Explicit collusion would need evidence of a planned agreement between the firms.

Key concepts

Oligopolistic Market

An oligopolistic market is characterized by the presence of a small number of firms that have significant control over market prices and output. In such environments, the actions of one firm can greatly affect the others, often leading to a high degree of interdependence among competitors. Because there are only a few players, each firm must consider the potential reactions of its rivals when making decisions about pricing, production, and marketing strategies.

One common occurrence in oligopolistic markets is the adherence to price points set by competitors, a practice sometimes resulting from what is called 'implicit collusion', which can happen without any explicit agreement. Firms in an oligopoly may avoid price wars by matching price changes made by rivals, effectively maintaining stable prices across the market. This strategic behavior helps firms avoid the uncertainties and potential losses associated with aggressive price competition.

Price Leadership

Price leadership occurs when one firm, often the largest or the most dominant in an industry, informally sets the price level that the other firms in the market follow. This implicit form of coordination is not illegal, unlike explicit collusion, and is often observed in oligopolistic markets where firms prefer to maintain industry stability rather than engage in price wars.

In price leadership, the leading firm effectively becomes the 'price setter' and others, the 'price takers'. When the price leader changes its prices, other firms in the industry quickly adjust their own prices to match. This tactic allows smaller firms to avoid the cost and risk of setting their own prices and enables the industry to maintain higher profit margins. The price leader's actions provide a focal point around which other firms can coordinate their pricing strategies without direct communication.

Implicit Collusion

Implicit collusion refers to a situation where firms in an oligopoly indirectly coordinate their actions without an explicit agreement or communication. Unlike explicit collusion, it does not involve direct negotiation or a formal arrangement to fix prices or output levels. Implicit collusion often takes the form of price matching or follow-the-leader behavior, as seen in price leadership models.

One indicator of implicit collusion can be the quick adjustment of prices by firms in response to price changes initiated by one company in the industry. The key factor differentiating it from explicit collusion is the absence of documented agreements among firms to fix prices or other market variables. Implicit collusion can occur naturally in a market with few competitors, as firms tend to read and react to each other's pricing signals in a consistent pattern, maintaining market stability and preserving profits without engaging in illegal activities.