The inherent weakness of Price Collusion; D. T. Armentano

Dr. Armentano is Assistant Professor of Eco nomics at the University of Hartford in Con necticut. An Substitutes The responsiveness of buyers to price changes is of crucial impor tance when considering the poten tial effectiveness of price-fixing agreements. If, for example, the commodity to be price-fixed has few good substitutes, an increase in its price may increase total revenues of the conspiracy and make price collusion financially re warding, at least in the short run. But if, as more often is the case, there is a plentiful array of goods that might be substituted for the commodi ty that is being price fixed, the higher fixed price may push marginal buyers to the cheaper substitutes, and thus low er total conspiracy revenues. This consequence encourages firms to break the agreement to maintain a uniform price since the agreement does not, apparently, work in their interests. Certainly some firms will be relatively worse off with regards to substitute com petition than others, and would be 1970 THE INHERENT WEAKNESS OF PRICE COLLUSION 41 the first to feel the pinch of a rev enue squeeze, and the first to con sider a policy of selective price re ductions. Thus, the threat of sub stitute competition may make price conspiracy difficult to form in the first place or lead to com petitive price reductions that break the conspiracy apart.

Changes in Demand A slight, even temporary reduc tion in demand for the price-fixed commodity may break apart the price agreement; recession is the natural enemy of successful price collusion. A decrease in demand at fixed prices will curb sales, and the temptation to ease the decline with a price reduction will be strong, especially for any low profit firm involved. Since all firms differ in financial strength, and in their willingness to "ride out" a demand decline, there must be such temptations and such pro ducers. When the relatively weaker firms cut price in an attempt to increase or maintain sales, the formal price-fixing agreements tumble. Output Agreements Firms that agree to fix prices also agree to some marketing ar rangement. Somehow, particular firms must be selected to "get" particular "jobs," or a particular percentage of industry output. This part of the conspiracy is crucial since it must produce proper revenues to all firms in volved else one or more of the conspirators will "chisel" price to steal orders. But these market share arrangements are all but impossible to sustain for any ex tended period of time. Will the present market shares be main tained and for how long? What arrangements will exist for alter ing the status quo? Will a smaller firm attempt to cut the fixed price when it feels that its alloted share or territory is too restrictive, and no operational procedures for change exist? And what about new firms attracted to the market by the higher than competitive prices? By definition, they have no allotted outputs or selling in structions; will they be content to just take a slice of the existing action? But which of the existing sellers will give up sales to make room for the newcomer? The tendency of output restrictions is to frustrate all aggressive sellers and attract new producers, and thus to weaken and eventually break apart price-fixing agree ments.

Costs Assume a (manufacturing) firm A whose production and selling costs - on the average - decline as output increases. As almost every 42 THE FREEMAN Jan.uary businessman realizes, there are "economies" associated with larg er outputs; "spreading the over head" and purchasing supplies in larger quantities tend to lower average costs per unit of output, and make larger outputs cheaper to produce and sell than smaller outputs. The significant point for this discussion is that firms that restrict outputs as part of a price conspiracy invariably raise their average costs per unit. Hence, profits will decline unless the ex tra revenue associated with the conspiracy exceeds the extra costs associated with the output restric tion. This important factor must surely make firms hesitant to join such restrictive a.greements. Smaller firms especially, will be anxious to increase - not decrease - output, in order to enjoy the economies associated with larger scale enterprise. To compete with larger, more efficient firms in the future may make this output ex pansion mandatory. In conclusion, price-fixing and output agreements are difficult to conclude when firms find it advantageous to increase, not decrease, their sales.

Imports As long as international mar kets are free (and it is within our power to lower our duties and tar iffs to zero on all goods), a domestic price-fixing conspiracy appears limited by foreign competition. When foreign goods are price com petitive, domestic price-fixing agreements are inherently unsta ble. A worldwide conspiracy is possible, but such arrangements have only existed and functioned successfully in the past with ac tive governmental support. Honesty and Trust Of course, honesty and trust be tween the firms to a price con spiracy is absolutely crucial to its successful operation. If one of the conspirators thinks, or is lead to think, that anyone else is not liv ing up to the price-output agree ments (and they will have to police their own agreements), then price cutting is likely. And since it is hard to turn down old customers and their price requests, and diffi cult not to discount from book price when demand lags, and since all firms know this, the suspicion of price cutting will always be strong. Since firms don't trust each other in open competition, it is difficult to understand why they should suddenly trust each other in price conspiracy.

Buyer Power As a final point, some assump tion concerning the market power of the buyers is necessary to un derstand price collusion. The buy1970 THE INHERENT WEAKNESS OF PRICE COLLUSION 43 ers must, obviously, have a rela tively weak bargaining position compared to that of the selling conspiracy. If buyers are large firms that can threaten to make the price-fixed item or import it, or can use reciprocal agreements to the detriment of the price con spirators, then successful price conspiracy certainly becomes more difficult. It is hard to imagine Sears, DuPont, American Can, or any of America's industrial giants being the victim 6f price con spiracy in their purchasing markets. Summary and Conclusions In summation, price-fixing agreements appear unstable or un workable when substitute compe tition is important, demand is fall ing, large producers are not party to the conspiracy, production quotas are to be agreed upon, larger outputs are cheaper per unit than smaller outputs, imports are an important part of market competition, mutual distrust and suspicion abound, and where buy ers are in a position to bargain.

Any or all of these factors might be enough to prevent successful price-fixing. Since almost all free markets, at one time or another, display these conditions, it ap pears reasonable to conclude that successful price collusion would be of negligible proportions, even without antitrust legislation. Finally, it might be, important to note that the record of many price-fixing cases prosecuted under our Sherman Antitrust Act has revealed a conspicuous lack of price-fixing success. With few ex ceptions, the prices have not been really fixed and have not been uni form for any substantial period of time; the evidence indicates that the agreements have broken down with almost monotonous regular ity. Firms have been convicted for having a price-fixing agreement or "tampering with price struc tures" 'or agreeing to charge the same price, but rarely, if ever, for having accomplished 'successful price collusion. Thus, much of the factual and empirical evidence con cerning price collusion appears to bear out the general correctness of the theories examined in this paper. ® "'~:"'~":"·::.:'·~1;".·'~'••":'~:""'::'·:.·:"·:,:•..•', ,. ~~ I I :'~.... 'illiJl~... ~..~~=to I If4 GUSTAVO R. VELASCO THE CENTRAL PROBLEM of our time is the economic organization of society. It is not necessary to ad here to historical materialism in order to recognize this or to real ize, as well, that upon the manner in which society solves this prob lem depends the resolution of many others which today appear to be insoluble, such as the discovery of a way to overcome and transcend present nationalisms, the estab lishment of peaceful conditions in the world, and the utilization for constructive ends of the latest wonderful discoveries of science.