The Impact of Cyclical Demand Movements on Collusive Behavior

Recent work by Rotemberg and Saloner (1986) investigates the effect of the business cycle on optimal collusive pricing by specifying that demand is subject to i.i.d. shocks. An implication of the i.i.d. assumption is that firms' expectations on future demand are unrelated to the current level o...

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Bibliographic Details
Published in:The Rand journal of economics 1991-04, Vol.22 (1), p.89-106
Main Authors: Haltiwanger, John, Harrington, Joseph E.
Format: Article
Language:English
Subjects:
Business cycles
Business structures
Cheating
Collusion
Corporate profits
Countercyclicality
Demand
Discounts
Economic fluctuations
Economic models
Economic recessions
Economic theory
Impacts
Market demand
Market prices
Price fixing
Pricing
Procyclicality
Recessions
Studies
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Summary:Recent work by Rotemberg and Saloner (1986) investigates the effect of the business cycle on optimal collusive pricing by specifying that demand is subject to i.i.d. shocks. An implication of the i.i.d. assumption is that firms' expectations on future demand are unrelated to the current level of demand. We put forth a model that allows for both the level of current demand and firms' expectations on future demand to change over time; thus it captures two important properties of the business cycle. Our analysis reveals that while the gain to deviating from a collusive agreement is greatest during booms, firms find it most difficult to collude during recessions, as the forgone profits from inducing a price war are relatively low. An implication of this effect for pricing behavior is that at the same level of demand, price is lower when demand is declining than when demand is rising. Consistent with previous theoretical work, we find that firms price countercyclically for a range of values for the discount factor. However, numerical simulations reveal a greater tendency for firms to price countercyclically during recessions than during booms.
ISSN:0741-6261
1756-2171
DOI:10.2307/2601009