International School of Economics at Tbilisi State University

THE ROLE OF PRICING MARKERS IN

DETECTING COLLUSION
(Literature Critique)

Author: Salome Goglichidze

Supervisor: Michael Fuenfzig

ISET 2012

Contents
Introduction ................................................................................................................. 3
Fundaments of theories on oligopoly and collusion ..................................................... 7
Collusive model with demand luctuations.................................................................... 9
Collusive model with cost fluctuations ...................................................................... 11
Empirical support for price rigidity............................................................................ 19
Conclusion................................................................................................................. 24
References: ................................................................................................................ 26
Appendix: .................................................................................................................. 29

Introduction
The market share and the increasing prices on the products of various big companies in
Georgia have recently provoked extensive discussions on the topic of passing an antitrust law and
regulating the competition environment among firms according to the requirements of the existing
European model. In order to conclude a free trade agreement with the European Union (EU),
Georgia needs to fulfill the EU requirements and reestablish a state agency which regulates
competition and restricts monopolistic behavior in the Georgian market.
After the collapse of the Soviet Union and while shifting from the planned economy to the
free market environment, Georgia faced the necessity to introduce antitrust legislation, such as
competition laws. These laws were passed in 1996 along with the establishment of the Georgian
State Antitrust Agency. The main function of the agency was to suppress antitrust activities and the
methods unconscientiously used in the competitive environment. In 2005, the laws were annulled
and the agency lost its power to intervene in regulating the market. It can now only control the
actions of government authorities in discriminating between economic agents while assisting them
with the state purpose-oriented programs. According to the authorities claims, the liberal economic
course of the country was the reason for reducing the power of the agency. Moreover, corrupt
activities and inefficient management hastened the process of its abolishment.
On its way to the EU integration, Georgia has to adjust to the legislation of the Union and
fulfill its requirements, such as adopting or improving relevant legal regulatory acts, considering
international practice and adopting laws on the experience of efficient regulation (Ketevan Lapachi
2012). Therefore, recently, in March 2012, after prolonged debates, the Georgian parliament finished
discussing a draft law on Free Trade and Competition. The new legislation concentrates not only
on the anticompetitive actions of the governmental authorities, but also fights against anticompetitive
agreements, a firms dominant position on the market and concentration of the firms. This version of

the draft law is very close to the European competition policy that is based on the following five
main principles:
the prohibition of agreements which restrict competition (Article 81)
the prohibition of abuses of a dominant position (Article 82)
the prohibition of mergers which create or strengthen a dominant position (Merger
Regulation)
the liberalization of monopolistic sectors (Article 86)
the prohibition of State aid (Articles 87 and 88).
Having market power is not illegal in itself, unless it is used illegally. Usually, antitrust laws
are exactly the tools for eradicating such abuses of the power. There is no doubt that Georgia needs
to have a policy with regards to market competition. According to official statistics, the market share
of small and middle firms in 2010 was only 15%, which is about two times less than the same
indicator for the year of 2000, when the share of small businesses only was 33%. Thus, some experts
claim that there are monopolies in every sector of Georgias economy (Paata Zaqareishvili 2012).
Consumers mainly complain about two sectors: the pharmaceutical and gasoline markets. A
few years ago Aversi and PSP shared the largest part of the pharmaceutical market and set similarly
exaggerated prices. After the entrance of other companies into the market the situation has changed a
bit, as these two original companies have been trying to attract buyers by offering discounted prices
on the products and bonus cards for points accumulation. But still, since Aversi and PSP produce
certain medicines domestically and act as suppliers for various small firms, the prices still remain
high and anticompetitive behavior is in doubt. As for the gasoline market, while comparing the world
market price of oil and the price of gasoline in the Georgian gas-stations, customers have suspicions
about the presence of a collusive scheme in this sector. Although cooperation is sometimes useful, in
most cases agreements on quantities or prices result in higher social loses than benefits (Porter 2005).
Adopting a new law should protect buyers from paying exaggerated prices, but the introduction of a
new policy is a very sensitive process. Regulating a negative process should not allow for another
4

illegal activity. Good example of this could be an Australian regulation, Fuelwatch (Fuelwatch
2012), which reduces price volatility by allowing gas stations to change prices only once per day.
Although the goal of this regulation was to reduce prices, it resulted in increased mean prices of oil
products.
Therefore, the rationale for an active antitrust policy could be that cartels or monopolies are
usually bad. Just being a monopoly is not illegal, but anti-competitive behavior is against the law. An
example of such behavior could be a monopoly engaging in practices to stall the emergence of
competitors, or firms forming a cartel. Overall, to differentiate legal activities of the firms from the
ones that are against the law and to suppress the incentives to involve in a collusive scheme, an
economy needs proper legislation against monopolistic behavior and its active enforcement. The
problem is that cartels are difficult to detect. There can be some criminal evidence, mostly
whistleblowers or confessions of former allies, but the question is whether economists have
something to contribute to the detection of cartels too.
A broad variety of literature concentrates on building models describing cartel behavior and
identifying different approaches to reveal collusive schemes. Screening methods are one of the most
applicable methodologies when detecting cartels. By using statistical techniques, screening reveals
the existence of various doubtful patterns of accessible information about prices, costs, bids or
market shares. Abrantes-Metz et al. (2006) and Esposito and Ferrero (2006) examine price and cost
data to find out the features they have around the period of collusion. Market shares are also
important in the process of detection. Relying on theory and empirical evidence, Harrington (2006)
claims that cartels are fixing market shares. Porter and Zona (1980) describe bid-rigging screens and
conclude that regression models can be used to examine the market environment. List, Millimet and
Price (2005) and Bajari and Ye (2003) are also concerned with collusion in auctions. The latter
examine bidding characteristics and conclude that, in the competitive market, they are highly
correlated with different kinds of costs.

My literature critique is motivated by the abovementioned facts of obvious uncompetitive

prices on the particular markets in Georgia. The issue whether prices can be considered as markers of
collusion is of interest. I will review papers focusing on price characteristics when collusion is in
presence and draw arguments about considerations that high price means or low variances can be
regarded as an indispensable indicator of prosecution. Although some authors develop an idea that
price variations result from a shift in regimes (Green and Porter 1984), there are several types of
theoretical and empirical analyses that corroborate the aforementioned view. Reviewing the vast
literature on this topic enables me to make a number of concluding remarks and suggestions about
the appropriate models that can be used while detecting the existence of collusive agreements on the
Georgian market.
The structure of the following literature critique is as follows: section 1 is dedicated to the
motivation that prompted economists to further expand the existing models that reveal collusive
features of the firms. Section 2 contains the review of a fundamental paper in which the author
argues that collusion is characterized by price wars. Section 3 analyzes the views of some
economists, who conclude that based on different assumptions price rigidity is more predictable to
the conspiratory scheme. Section 4 illustrates papers examining the collusion issue in particular
industries and environments mostly related to the case of Georgia. My concluding remarks are
provided in Section 5.

Fundaments of theories on oligopoly and collusion

Pricing patterns are one of the important issues discussed in the economic literature.
Economists have been trying to contribute to the cartel-detection process by building and solving
models that enable them to observe pricing patterns of collusion. To start with the discussion of the
simplest models of oligopoly, Cournot and Bertrand explore the non-cooperative profit maximizing
equilibrium features of the firms. While these two models rely on the same assumptions about
demand, cost and homogeneity of products, they view profit maximizing behavior differently. In the
Cournot model the decision is made about quantities produced, since Bertrand competition is based
on price choices. Both models imply that the best choice for the firms is to collude, but the
assumption of a non-existent collusion leads to very simplified implications and the firms
equilibrium prices are set differently. In the Cournot equilibrium, firms have positive markups,
which decrease to the marginal cost when the number of the firms increases1. In contrast to Cournot
model, under the same assumption of non-colluding firms, Bertrand equilibrium results in the fact
that even two firms are enough to set the price equal to marginal cost. Although collusion is illegal,
relaxation of the no-colluding assumption enables to eradicate the drawback of the models and
explore a more developed pricing scheme.
Stigler (1964) made one of the first steps in accepting the collusive behavior of firms and
formulating a framework for the conditions that ensure a successful operation of collusion. The
theory of oligopoly by Stigler motivated the subsequent literature to conduct new investigations and
develop theories in the sphere of detecting illegal agreements among firms and to shed light on the
characteristics of such conspiracies. His main contribution to the literature is the fact that his model
deviates from the static Cournot framework and poses the question of whether a cartel can be stable
in a dynamic setting even in case of informal collusion. Unlike Cournot, whose model determines the
industry performance relying on the number of the firms and homogeneous products, Stigler offers a
1

Ruffins (1971) conclusion should be mentioned here claiming that, under free entry and constant returns to scale
economy, number of the firms cannot influence on the competitive solution.

non-cooperative model of oligopolistic firms under the existence of constraints on new entries and
product differentiation. He rightly mentions that, as a deviation from the agreement results in higher
profits, incentives to cheat are higher and, thus, proper enforcement is needed to eradicate these
incentives. The best way to do this is to fix market shares which make it easier to reveal price-cutting
incidences. The model predicts that if there are no movements of buyers among sellers, sharing the
market rules out deviations from agreement. Also, if buyers such as the government, report true
prices offered to them, colluding is the best choice (Stigler 1964).
Stiglers idea is related to the result of the older model of Bertrand that claims that under the
same marginal costs of production non-cooperative equilibrium in the static game is to set the same
prices. In addition, the model also involves the existence of opportunities to earn high profits by
secret price-cuttings before detection. This hypothesis is not rejected by Stigler. However, the author
describes conditions that minimize incentives to reduce the price. Friedman (1971) and Osborne
(1976) also conclude that reactions of the rivals on price reductions as well as output changes do not
cause firms to deviate. Nonetheless, it becomes much more confusing to rely on the real world
outcomes and claim whether data about the firms identical prices results from their collusive or
competitive behavior (Bresnahan 1982).
Thus, the traditional view about cartel pricing in a particular industry has been formed in such
a way that a price drops for a certain period and then its sharp increases might have two reasons.
Firstly, such behavior can be a cause of the existing competitors response to a vulnerable entry of
new firms on the market and therefore, price reductions are the cause of failure of a collusive
agreement that is followed by a new contract. Secondly, this kind of a price pattern might indicate
weakness of the existing agreement.

Collusive Model with Demand Fluctuations

The substance of the above-mentioned works in determining conditions for successful
agreements among firms has served as a motivation for Green and Porter (1984) to observe
characteristics of a self-enforcing cartel operation. When traditional models may consider variations
in prices as a prediction of collapsing conspiracies, Green and Porter argue that an industry,
characterized by certain features, can show this kind of price changes even when there are no signs
of collusion failure.
According to the assumptions, the outcomes of the model are worthy for the industry that is
stable over time, in which the firms can only manipulate their production levels and not product
differentiation or market division. Unlike in Cournot model, firms present and past output quantities
are not known and this is the only private information on the market. Price data, along with demand
or market share information, serve as variables under monitoring.
The authors present a model of collusion under an uncertain environment, in which prices
vary according to the conspiratory phases. The industry is characterized by homogeneous products
that have the same market price. Firms maximize their expected profits relying on their risk
neutrality assumption. It is also assumed that expected profits from their contingent strategy for Nash
equilibrium are greater or equal than for any other contingency. The model is an improvement of
Cournot version of oligopoly in a sense that it considers the essential assumptions of demand
variability and uncertainty. The firms monopolistic behavior is accompanied by high prices, while
falling prices switch them to the Cournot competition. Thus, firms make their monopolistic choices
about their production level by comparing the market price to their agreed trigger price. Unlike
Stigler model, Green and Porters model considers the firms reactions to deviation of the other
firms. The firms initial production is set according to monopolistic shares that will be maintained
until the market price reduces below the triggered price. At this point, firms will switch to Cournot
outputs during their reversionary period, without taking into account what the price level is and
9

finally, after the reversionary period is over, they will resume producing monopolistic outputs. The
incentive constraint for deviation is that the marginal benefit from increasing output during the
normal period has to be offset by the marginal loss from reversions.
The authors observe two main findings from the model. First, there is no private information
that firms possess, which encourages them to deviate from the agreed conditions. Hence, contestants
are able to guess the profit maximizing decisions of others and the market price can reflect only
demand information, not the competitors production. Second, regardless of concluding that low
prices are due to demand and not the increasing share of others products, firms still find it rational to
reverse. In essence, deviating from Nash strategy even temporarily does not give any benefits to
them, but otherwise, as everyone is familiar with the equilibrium incentive properties, not reverting
to Cournot strategy in response to low prices would result in destroying optimality of monopolistic
behavior individually. Thus, Green and Porter claim that collusion is characterized by equilibrium
path price wars.
Rotemberg and Saloner (1986) also highlight pricing features in presence of observable
demand shocks that are iid over time. Unlike the previous case, although high demand shocks create
incentives to cheat, firms jointly decide to decrease their collusive price. Thus, prices still vary, but
price wars are not required to achieve equilibrium in this model. However, by simply observing
pricing patterns under the assumption that costs are the same for the firms, conclusions about cartel
pricing features cannot be drawn. Several papers use novel approaches while discussing this crucial
issue about collusion and expand the existing models by introducing new variables. An important
and different finding these papers offer about prices is that their variance decreases during a
collusive period.

10

Collusive Model with Cost Fluctuations

Athey et al. (2004) present a model of standard collusion that is based on the infinitely
repeated Bertrand game framework. This model makes a huge contribution to the process of
determining whether collusion under cost shocks causes price rigidity. The introduction of costs into
the model is quite intuitive and much more realistic, as it significantly determines firms behavior
(Athey and Bagwell 2008). Unlike Green and Porter model, the firms have different costs and
information about their costs is private within each period. Cost shocks, which are iid over time, are
introduced in the model. A decision about prices is made after the firms exchange information about
their own costs. Thus, the authors present the case of collusion with a repeated model of hidden
information, in which actions are observed only in terms of prices. The authors try to expand the
view of Industrial Organization economists, who claim that collusive firms are characterized by rigid
prices as this is a good mechanism to avoid unreliability among conspirators and to preclude price
wars (Carlton 1989). The main term of interest to the model is private cost variation.
The authors first consider a static Bertrand game, in which demand is inelastic and
information about costs is private. The firms with the lowest cost and with lower prices as well, have
an advantage which allows them to have the highest sales in this static Nash equilibrium. Hence, for
such firms, incentives to deviate are high. When moving to the discussion of the repeated game,
firms ability to generate profits under symmetric perfect public equilibrium (SPPE) is an interesting
issue to be described. This kind of collusive scheme is characterized by corresponding prices for
each type of cost. The differences from Green and Porter model arise when describing incentive
constraints to cheat. Athey et al. (2004) observe two types of constraints for the firms: for any level
of cost one ensures unwillingness of the firms to set a price that is not consistent with any cost type
(off-schedule deviation that results in price wars). This constraint is satisfied for patient firms in the
repeated game structure. The second constraint excludes incentives for on-schedule deviation, in
which private costs represented by a firm are overestimated and prices are set according to another

11

type of cost. Therefore, if in the former case everyone could guess that the firm is cheating, the latter
case excludes suspicions about such behavior.
The SPPE analysis is divided into two parts. In the first case the firms are patient. Here, offschedule constraint is in present and on-schedule constraint represents the informational cost of
collusion. The SPPEs main problem is that in the collusive scheme there should be no incentives for
highcost firms to misrepresent their costs and set lower prices to expand their market share. There
are two cases when such kind of informational costs of collusion may arise. Firstly, revealing real
information about costs is possible when low-cost firms agree on low prices which are not attractive
to high-cost firms. Secondly, after setting lower prices, the firms in collusion take into account future
price wars on the equilibrium path and their recent benefits outweigh the costs of these wars only in
the case when they really have lower costs at the moment.
Considering all the conditions mentioned above, the main term of interest is the firms pricing
schemes that can be represented in several ways. To begin with, in the Nash pricing scheme, firms
play the Nash equilibrium repeatedly in the static game. Also, in another case, future costs of price
wars are affected by collusive informational costs. Here, the on-scheduled constraint is satisfied if
equilibrium path price wars are preceded by price selection of lower cost firms. Moreover,
informational costs of collusion might be prevented if the firms agree on a rigid-pricing scheme. In
this case, efficiency benefits are forgone and the firms have to choose between efficiency benefits
and informational costs that arise due to an agreement between colluding firms.
Solving the model enabled Athey et al. (2004) to draw the following conclusions: under a full
sorting scheme of SPPE the firms find it difficult to operate. Outcomes in this case are not better than
even in the case of a Nash pricing scheme. When considering all the realizations of SPPE collusion
schemes, the result is that the optimal system does not require equilibrium path price wars. This
finding contradicts the Green and Porter (1984) predictions. Furthermore, when taking into account
the firms patience and log-concavity of their cost functions, the optimal SPPE framework is

12

described by rigid prices, which means that the firms have the same prices in each period regardless
of their cost levels.
Consideration of the case of impatient firms reveals another drawback of price wars. The
process of setting high prices currently accompanied by predictions about a war in the future
increases incentives of deviations today. The finding about non-optimality of equilibrium path price
war also holds for impatient firms. Besides, for low-cost firms, off-schedule constraint is needed as
the firms with lower costs are sure that they will have enough market shares for not having an
incentive to cheat. Another finding for impatient firms is that if they cannot maintain a rigid pricing
scheme, partially rigid pricing is the best choice when the prices are set at a low level to reduce the
incentives of low-cost firms to cheat. Thus, while introducing costs, price wars are rejected in Athey
et al. model, which contradicts the findings of older papers. However, the analysis should be
extended even further to describe the pricing patterns of collusion more precisely.
Harrington and Chen (2004) also discuss the problem of cartel pricing dynamics by
considering costs that vary for an individual firm over time, and more importantly, the authors
extend the model by introducing buyers beliefs to it. Harrington and Chen consider a situation when
colluding firms not only care about profit maximization by increasing prices, but also do their best to
prevent doubts about their illegal activity. This process is as important as avoiding deviations of
collusive firms like the ones discussed in the previous model. But here the authors analysis is more
developed and more in line with the reality since it incorporates buyers beliefs. However, the model
still suffers from a number of drawbacks as it relies on simplified assumptions that are discussed
below.
Harrington and Chen develop a model that concentrates on consumers beliefs as they, rather
than any other actors from the antitrust department, are regarded as the main detectives of cartels.
After deciding whether to collude or not the firms set prices relying on considerations about whether
cartels can be detected by buyers. The buyers, in turn, may call collusion under question after
observing unusual price paths. Depending on the cost variability assumption, which makes this
13

model more appealing along with accounting for the endogenous buyer problem, there can be two
different paths for cartel pricing: transitive and stationary. In the transitive times, a price changes
regardless of cost levels and in stationary times, price variations are linked to costs. Prices increase
initially in the transitory phase, but some specified parameters may become a reason of price
overshooting which causes convergence of prices from above. Sensitivity of prices in the stationary
phase assumes that they are less volatile than prices set by non-colluding or monopolistic firms.
Industries with less variable cost are characterized by a longer transition phase and more
overshooting.
Generally, cartel formation may suffer from detection that will be followed by a punishment.
Such kind of conspiracies may be revealed in different ways: customers may complain about prices
or whistleblowers might tell on their own companies. Irrelevant prices may become a reason for
customers doubts about collusion. As was mentioned above, this model takes into consideration
buyers beliefs and their suspicions, which allow them to guess that collusion exists in the present. The
authors review conditions in which a firms behavior may become a reason for buyers doubts. The
model assumes that if suspicions arise, detection cannot be avoided in case a cartel exists.
Buyers endogenous beliefs about cartel formation can be modeled as an incomplete
information game, in which buyers know prices in Bayesian Nash equilibrium. Besanko and Spulber
(1989) discuss the cases of cartel formation and non-formation relying on customer beliefs and their
awareness of pricing patterns of collusion. But the assumption about buyers knowledge of cartel
pricing is the drawback of this approach, as understanding the pricing scheme of a cartel is
problematic and is difficult to do even for experienced economists. Thus, Harrington and Chens
rejection of this assumption along with the assumption that buyers are conscious enough to detect
collusion is more valid when solving the model. They just consider that buyers may think there is
collusion if they observe some unpredicted changes in prices and strange paths of price variations.
Therefore, buyers hypothesize about prices in the model relying on the condition that firms in
the industry are competitive. This approach describes the hypothesis testing scheme. Once
14

consumers observe prices that do not follow their theory, they may think of rejecting their
assumption of competitive firms and accuse them of a conspiracy. Conditioning on the fact that a
collusion is present, it is important whether buyers take part in a breakdown of a cartel. Unlike the
previous models, Harrington and Chen (2004) characterize the market in the following way. There is
a symmetric oligopoly with a linear demand function; demand is fixed; firms marginal cost of
production is constant, but can vary over time due to various shocks. Herewith, the model assumes
that the firms know the method according which the buyers may become suspicious, but buyers do
not know how the firms set prices. The firms concern is not only to take into consideration buyers
beliefs but also foresee the penalties if they are detected by authorities.
To examine pricing patterns of collusion, the authors formulate several conditions and
compare results for the same parameters to those for non-collusive firms. Running the models by
selecting initial conditions for buyers beliefs and cost patterns and by randomly choosing a sequence
of cost shocks enables them to simulate eight different realizations of price paths. While observing
the patterns of these pricing processes, the model predicts that there are two periods for which
collusion can be revealed. In the early stage of transition prices rise steadily no matter whether cost
shocks happened or not. As for the stationary phase, prices move due to cost shocks. Comparing
collusive and non-collusive price paths shows that collusive prices are noticeably less responsive to
cost shocks.
As was mentioned above, the first important result drawn from the model is that during the
transition phase prices increase highly independently of costs and in the stationary phase they move
along with costs. Herewith, at the end of the transitional phase, the prices may decline
insignificantly. If prices increase rapidly, it might become a cause for cartel identification. Hence, a
firm chooses a strategy of increasing prices gradually so that buyers become adapted to price
variations and do not pay too much attention to the recent changes.

15

In the stationary phase, a cartel tries to adjust prices by relying on natural basis and by
following buyers beliefs. If buyers believe that prices should increase, a cartel price should increase
regardless of costs. But large cost shocks cannot force a cartel to adjust prices of non-collusive firms.
These are sufficient arguments to claim that, unlike the finding of Green and Porter (1984), prices are
less volatile under collusion.
One main feature of collusive firms is that, compared to competitive ones, their prices are
higher (Harrington 2006). As this way of increasing profits violates buyers rights, examining price
levels and preparing proper legislation to protect customers is the main goal of antitrust authorities
(Connor and Lande 2005). The advantage of Harrington and Chens paper, as compared to the ones
discussed directly above, is that it not only examines the variance of prices, but also discusses the
issue of raising prices by cartels. In the Harrington and Chen model the rate of price increase
depends largely on buyers beliefs. The transition phase shortens and prices rise faster when costs
vary greatly. In their turn, buyers beliefs in price changes depend on a non-collusive price variance.
Buyers are expected to anticipate a sequence of price increases in case of positive, but small, or
negative prices, as prices are believed to be more volatile. Here, the firms under collusion have less
danger of being detected and can increase prices in a short time period. If buyers expectations about
prices are adjusting quickly, conspirators have ground for price increase and they are even able to
raise prices in the current period. Thus, cartel pricing depends not only on trying to change prices
according to the buyers beliefs, but also on how a cartel can set these beliefs so that they seem to be
reasonable.
The second important finding of Harrington and Chens model is that the transition phase is
shorter and prices are rising faster when the variance of cost shocks is higher and buyers have
responsive beliefs about recent price changes. To have a better understanding of price variability
patterns, the authors simulate price paths again and conclude that cartel prices are less volatile
compared to non-collusive and even monopolistic prices. This outcome is consistent with AbrantsMetz et al. (2005) results, which report evidence of lower price variability under collusion. Finally,
16

the authors find that a cartel price highly overshoots when the cost variance is lower as well as the
firms future discounting and buyers beliefs are less responsive to it.
The advantages of the model developed in Harrington and Chen (2004) are that while taking
into account the factor of customers, the models simulated conditions reveal the patterns of real
cartel price paths. However, the model suffers from a number of disadvantages that should be
mentioned: this approach needs several strong assumptions about the process of how buyers form
their beliefs. Just assuming that buyers only have an understanding of equilibrium conditions and
cannot suspect firms in collusion is quite a simplified supposition. The real world is rather different
and consumers are usually the ones who blame firms for being involved in a collusive scheme, even
though they might be overzealous and might have misleading suspicions. Moreover, legislation of
some countries enables customers to take part in the cartel detection process. As the Parliamentary
Secretary of Georgia states, (Free Trade and Competition Agency) can serve any interested subject
as a qualified expert. Anyone, who can report the facts about restricting competition, can apply to the
agency (David Gamisonia 2012). This is a very important step forward in the process of improving
the competitive environment in the country, which makes cartel-detecting process more intense.
However, experts claim that the establishment of a new agency is just a formality to adjust to the EU
legislation, since its main function is only to monitor the existing environment and cannot prevent
the possibilities of building new schemes of collusion (David Gamisonia 2012). This argument is not
unreasonable because if there are sufficient incentives for the firms to generate profit by colluding
before being uncovered and prosecuted, they might use this opportunity and violate consumers
interests even only for a short period of time. Hence, if the new agency will be empowered with
additional powers and resources to not only detect cartels, but also to help prevent their creation, or
assist in preventing merges of the firms to raise the profits, and set fines that exclude the incentives
to collude, the law will be closer to its EU equivalent and Georgias competitive environment will be
more regulated.

17

Reviewing the existing models shows that there is still space for new findings in modeling
collusive features. Nevertheless, while talking about price markers of collusion in its theoretical
aspect, it is useful to discuss empirical evidence that supports and strengthens the findings that a
collusive scheme is characterized by a high price mean and low variance.

18

Empirical support for price rigidity

In their empirical work, Bolotova et al. (2005) find the abovementioned patterns of prices by
testing the hypothesis that under collusion the first two moments of price distribution are different.
To check the theory the authors apply econometric models, such as the autoregressive conditional
heteroscedasticity (ARCH) and the generalized ARCH (GARCH). Using them has an advantage of
having to acquire only a small sample size around the period of prosecuted collusion. The authors
use price data from the citric acid and lysine industries in USA, which were detected to be colluding.
In the citric acid industry four companies were found guilty to have an agreement on fixing prices.
Although one of the companies claimed that the agreement started in January 1993 and lasted till
June 1995, Connor (2001) claims that it started in 1991 and continued to affect the market price after
June 1995, as it takes time for prices to adjust to the level they had before collusion. Thus, the data
for this industry was taken for 1990-1997 years. As for the lysine industry, collusion is considered to
take place for 1992-1995 years, excluding the period April-July 1993, when the conspiracy failed
and the data was collected for 1990(January)-1996(June) years.
AR(m), ARCH(m) and GARCH models enables the authors to examine the behavior of the
mean and variation of prices simultaneously. AR(m) autoregressive process of order m for
observable variable

t 1

has the form:

t2

...

is an error term. E u t 0 ;

tm

ut

(1)

E (u u ) for t

and 0 otherwise. From the latter

condition it follows that the unconditional variance of the error term is constant over time, while its
conditional variance might change.

2
t

1 u t 1
2

2
t2

...

2
t

may have a form:

2
tm

white noise term and its expectation is 0 as well. E

that is called ARCH(m). Here

w w
t

for

w is
t

a new

s and 0 otherwise. O
19

and

for all j

m ensure the stationarity of the process.

The variance equation of GARCH (r,m) can be formed as:

h
1

t 1

h
2

t2

...

h v and vt is iid and vt

t

tr

2
t 1

2
t2

...

2
tm

(0,1) .

The requirement for stationarity here is that

o for all i r , o for all

j

, and sum of all and should not exceed 1.

Estimating extensions of ARCH and GARCH models enables the authors to examine the first
two moments of price distribution and to see whether they have an important pattern when collusion
is present. The predictions are that, in case of collusion, mean prices are high and variance is low
relative to non-colluding periods.
For the lysine industry prices follow the predictions about mean and variance, while for the
citric acid industry only the price mean supports the hypothesis (Appendix, Table 1-6). Still, the
authors do not reject the belief that collusion results in lower price variability and state two possible
reasons why price variation is lower for the lysine during conspiracy, while it is higher for the citric
acid industry. First of all, the colluding period for citric acid was longer compared to lysine industry.
Hence, in the long run variability of prices might be the case due to deviations of cartel members. A
supporting argument for this observation can also be that in the lysine industry the cartel operated
very successfully and none of the members deviated from the agreement. Secondly, missing data
may become a problematic issue while talking about results. The number of observations collected
for the citric acid industry for the period when the cartel has not been founded yet is about two times
smaller than the same kind of observations for lysine and is also smaller than the observations for the
cartel period. Therefore, prices may seem to be more volatile in the presence of collusion.
On the whole, if the firms in the specific market are suspected to be colluding, econometric
techniques can be used to test their behavior. Antitrust authorities are free to use these methods for
screening analyses. Bolotova et al. (2005) also recommend using the existing econometric techniques
20

in court when observing how conspiracy affects market price. Using ARCH and GARCH models has
an advantage in that they require only a small sample of prices for cartelized products over the
period of these industries being involved in a conspiracy. Even more importantly, these methods
have shown supporting patterns of the analyses: high means of prices and low variances in presence
of collusion. Hence, these methods can be appropriate while finding out whether there is collusion in
the Georgian pharmaceutical market.
In the process of shedding light on the pricing features, Abrantes-Metz et al. (2006) check the
movement of prices before and after the break-down of bid-rigging conspiracies. They examine the
first two moments for the prices in the seafood industry, a collusion which was prosecuted by the
Antitrust Division of the US Department of Justice. The firms were blamed to be involved in a bidrigging conspiracy for 1984-1988 years. They not only made agreements about making bids and
fixing prices, but were also secretly engaged in selling Canadian fish to the US Defense Department
as if it was fish caught in the US by the native fishermen. The conspiracy failed because some of the
members deviated from the agreement (Abrantes-Metz et al. 2006). Therefore, examining price
characteristics in this industry might reveal some interesting features. Abrantes-Metz et al.
concentrated on the prices of frozen perch fillets, as they were one of the heavily purchased products.
They find that the collapse of the cartel resulted in reducing the mean price by 16% and in increasing
the standard deviation by about 260%. The corresponding statistics for cost data under competition
was also high, but, relying on Harrington and Chens paper, the authors are correct in claiming that
this cannot be considered as a sufficient reason for explaining price variations (Appendix, Table 7).
Genesova and Mullin (2001) discuss the case of the Sugar Institute, where 14 firms were
colluded during the years of 1927-1936. The situation was somewhat different as the cartel was just
regulating transactions and not setting prices or production levels. Still, the collusive period margin
of sugar refining turned out to be higher, while its variance lowered significantly compared to the
pre-cartel period.

21

Obviously, a conspiracy results in high prices on products accompanied with a low variation
of these prices. Abrantes-Metz et al. believe that similar characteristics for other industries might
become a guide to observe a collusive scheme. Thus, with the help of a variance screening, they try
to examine the features of prices in the retail gasoline market in US, Louisville.
The advantage of the screening method used by the authors is that there is no need for using
cost data, it has a known distribution and is easy to estimate. Moreover, it has theoretical and
empirical support. The authors use an interesting method to observe pricing features. They have data
from the Oil Price Information Service (OPIS) that is collected when gasoline purchasers use fleet
cards. When a purchase is made at the station, the price is recorded for that station for a given day.
Thus, if there are no purchases made with a fleet card, data is missing for the specific station.
Therefore, stations selling more gasoline appear frequently in the sample on a given day. Branded
stations that accept fleet cards more often are also expected to be in the sample. Hence, the data
includes ten different brands that exist in the gasoline market as well as other unbranded stations.
The authors use multiple imputation, more concretely, Markov chain Monte Carlo with Gibbs
sampling combined with data augmentation to fill the missing observations.
The procedure of filling the incomplete data using simulation-based method is as follows:
1. Creating imputations by replacing missing observations by m>1 values;
2. Analyzing with the same method each of the m datasets;
3. Combining the results.
The authors compute the mean, the standard deviation and the coefficient of variation for
each station and try to find out whether there are stations with a high mean and low variance.
If stations appear in the lower right corner on the figure with the mean prices on the
horizontal axis and variation on the vertical axis, it might mean that they are involved in a collusive
scheme. The authors analyze the resulting data by choosing four regions for each measure divided by
the following cutoff points: mean minus standard deviation, mean and mean plus standard deviation.

22

Division of the data into these categories enables the authors to examine whether there are outliers
that can be considered to be conspirators.

Source: Abrantes-Metz, R., Froeb, L., Geweke, J. and Taylor, C. (2008). Fig.4

The findings the authors get show that the low variance in prices emerged mainly for the
stations that are owned and operated by a company, while more volatile pricing appeared for locally
owned stations. Besides, geographic distribution of stations has an interesting pattern: locations of
the stations with a higher mean are mainly major roads or the center of Louisville. The outcomes of
the survey do not give the authors ground to blame the gasoline stations for collusive behavior.
However, the method used by Abrantes-Metz et al. is still interesting for us since it can be applied to
detect collusion in the Georgian gasoline market which is suspected of being involved in a collusive
scheme.

23

Conclusion
The paper reviews the existing literature about pricing patterns of collusion in order to shed
light on price characteristics in presence of an illegal agreement among firms and in order to check
whether prices can really be considered as valuable markers of collusion.
Stigler (1964) introduced the non-cooperative model of oligopolistic firms and built a
framework for successfully operating a collusive scheme. His work motivated economists to further
develop an oligopolistic theory and examine several features of collusion. Green and Porter (1984)
argue against the traditional viewpoint that price variations are not the signs of a conspiracy break
down and that collusion is characterized by price wars. According to Green and Porter model, the
firms initial production is set to monopolistic levels and a price reduction done by one of the firms
switches them to Cournot output levels. Deviation from the agreed prices in the model is due to
observable demand changes and not an increase in the share of ones production. Despite the fact
that the firms find unprofitable to deviate from the Nash strategy, they still revert to the Cournot
output as a failure to do so would mean non-optimality of individual monopolistic behavior.
Unlike Green and Porter (1984) model, in which only demand shocks matter, Athey et al.
(2004) and Harrington and Chen (2004) present expanded collusive models, which illustrate pricing
patterns of conspiracy. While the former describes the collusive scheme with a repeated model of
hidden information about costs under observable prices and examines the effect of iid cost shocks,
the latter incorporates buyers beliefs in the model as well and discusses the problem of cartel pricing
dynamics. Solving the model regarding on and off-schedule constraints for patient and impatient
firms enable Athey et al. to reject optimality of equilibrium path price wars regardless of their cost
levels. Adding buyers beliefs to the model created by Harrington and Chen (2004) also does not
change the latter outcome. Their more realistic assumptions have also revealed that colluding firms,
not only thinking about profit maximization by increasing prices, but also trying to prevent doubts
about their conspiratory behavior, operate in transitional and stationary phases. Prices increase in the
24

transitional phase and may decline slightly at the end of this period, while in the stationary phase
they follow behavior anticipated by buyers. Harrington and Chen (2004) model also discusses mean
price levels of colluding firms and, finally, by showing that mean prices are higher and variances are
lower, rejects the existence of price wars.
The model outcomes are summarized in the following diagram:
Demand

Cost

Price behavior

Green and Porter (1984)

stochastic

constant

price wars

Athey et al. (2004)

constant

stochastic

rigid prices

Harrington and Chen (2004)

constant

stochastic

rigid prices

To support theoretical models which claim that mean price increases and variance is low in
the presence of collusion, two empirical papers are discussed. Bolotova et al. (2005) examine the
first two moments of price distribution by using data from two prosecuted industries of citric acid
and lysine. Applying ARCH and GARCH models allows them to find consistent evidence to support
the existing literature. Examination of price behavior before and after the break-down of a bidrigging conspiracy by Abrantes-Metz et al. (2008) shows that the collapse of a cartel decreased the
price mean by 16% and increased standard deviation by 260%. Relying on the observed
characteristics, the authors examine price patterns for the retail gasoline market in Louisville to find
out whether there is a collusion. They collect daily data for different stations and use Markov chain
Monte Carlo with Gibbs sampling combined with data augmentation to fill in the missing
observations. These two approaches discussed above can be applied to examine the competition
environment in the Georgian markets. More precisely, ARCH and GARCH methods are more
appropriate for the pharmaceutical market, while the method used by Abrantes-Metz et al. will be
more helpful for checking the gasoline market.

25

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28

Appendix:

Bolotova, Y., Connor, J. and Miller, D. (2008) Table 1.

Bolotova, Y., Connor, J. and Miller, D. (2008) Table 2.

29

Bolotova, Y., Connor, J. and Miller, D. (2008) Table 3.

30

Bolotova, Y., Connor, J. and Miller, D. (2008) Table 4.

31

Bolotova, Y., Connor, J. and Miller, D. (2008) Table 5.

32

Bolotova, Y., Connor, J. and Miller, D. (2008) Table 6.

Table 7
33

Abrantes-Metz, R., Froeb, L., Geweke, J. and Taylor, C. (2008). Table1.

34